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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • Match each statement with the correct term.
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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. 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






2. Strategic risk - Business risk - Reputational risk






3. Quantile of a statistical distribution






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






5. Returns on any stock are linearly related to a set of indexes






6. 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






7. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund






8. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






9. 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.






10. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)






11. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return






12. 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






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






14. 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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15. 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






16. CAPM requires the strong form of the Efficient Market Hypothesis = private information






17. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)

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






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






20. 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






21. Asset-liability/market-liquidity risk






22. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM






23. Prices of risk are common factors and do not change - Sensitivities can change






24. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






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






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






27. Both probability and cost of tail events are considered






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






29. Capital structure (financial distress) - Taxes - Agency and information asymmetries






30. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls






31. Multibeta CAPM Ri - Rf =






32. Future price is greater than the spot price






33. Volatility of unexpected outcomes






34. Modeling approach is typically between statistical analytic models and structural simulation models






35. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






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






37. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






38. Need to assess risk and tell management so they can determine which risks to take on






39. Unanticipated movements in relative prices of assets in hedged position






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






41. Quantile of an empirical distribution






42. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






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






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






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






46. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






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






48. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits






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






50. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities







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