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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
  • If you are not ready to take this test, you can study here.
  • Match each statement with the correct term.
  • Don't refresh. All questions and answers are randomly picked and ordered every time you load a test.

This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.
1. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits






2. When negative taxable income is moved to a different year to offset future or past taxable income






3. Absolute and relative risk - direction and non-directional






4. Proportion of loss that is recovered - Also referred to as "cents on the dollar"






5. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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6. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






7. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated






8. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






9. Expected value of unfavorable deviations of a random variable from a specified target level






10. Concentrate on mid- region of probability distribution - Relevant to owners and proxies






11. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






12. Curve must be concave - Straight line connecting any two points must be under the curve






13. When two payments are exchanged the same day and one party may default after payment is made






14. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations






15. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized






16. Designate ERM champion - usually CRO - Make ERM part of firm culture - Determining all possible risks - Quantifying operational and strategic risks - Integrating risks (dependencies) - Lack of risk transfer mechanisms - Monitoring






17. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi






18. The lower (closer to - 1) - the higher the payoff from diversification






19. Quantile of a statistical distribution






20. Changes in vol - implied or actual






21. Track an index with a portfolio that excludes certain stocks - Track an index that must include certain stocks - To closely track an index while tailoring the risk exposure






22. Country specific - Foreign exchange controls that prohibit counterparty's obligations






23. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset






24. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






25. Firms became multinational - - >watched xchange rates more - deregulation and globalization






26. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection






27. Relative portfolio risk (RRiskp) - Based on a one- month investment period






28. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






29. Interest rate movements - derivatives - defaults






30. Derives value from an underlying asset - rate - or index - Derives value from a security






31. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






32. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






33. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations






34. Inability to make payment obligations (ex. Margin calls)






35. Law of one price - Homogeneous expectations - Security returns process






36. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders






37. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and






38. Probability distribution is unknown (ex. A terrorist attack)






39. The uses of debt to fall into a lower tax rate






40. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






41. The need to hedge against risks - for firms need to speculate.






42. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk






43. Quantile of an empirical distribution






44. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






45. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -






46. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio






47. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






48. Risks that are assumed willingly - to gain a competitive edge or add shareholder value






49. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






50. Concave function that extends from minimum variance portfolio to maximum return portfolio