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






2. Volatility of unexpected outcomes






3. Losses due to market activities ex. Interest rate changes or defaults






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






5. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses






6. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it






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






8. Both probability and cost of tail events are considered






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






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






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






12. Asset-liability/market-liquidity risk






13. Rp = XaRa + XbRb






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






15. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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






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






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






19. Asses firm risks - Communicate risks - Manage and monitor risks






20. Covariance = correlation coefficient std dev(a) std dev(b)






21. No transaction costs - assets infinitely divisible - no personal tax - perfect competition - investors only care about mean and variance - short- selling allowed - unlimited lending and borrowing - homogeneity: single period - homogeneity: same mean






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






23. 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






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






25. 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






26. Hazard - Financial - Operational - Strategic






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






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






29. Quantile of an empirical distribution






30. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






31. 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






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






33. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






34. 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






35. Strategic risk - Business risk - Reputational risk






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






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






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






39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds






40. Wrong distribution - Historical sample may not apply






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






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






43. Return is linearly related to growth rate in consumption






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






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






46. Risk of loses owing to movements in level or volatility of market prices






47. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely






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






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






50. Multibeta CAPM Ri - Rf =






Can you answer 50 questions in 15 minutes?



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