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






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






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






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






5. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements






6. 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.






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

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






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






10. 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






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






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






13. Changes in vol - implied or actual






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






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






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






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






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






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






20. 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






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






22. Volatility of unexpected outcomes






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






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






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






27. Probability that a random variable falls below a specified threshold level






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






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






30. Return is linearly related to growth rate in consumption






31. 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






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






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






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






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






36. Occurs the day when two parties exchange payments same day






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






38. Interest rate movements - derivatives - defaults






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






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






41. Quantile of a statistical distribution






42. Potential amount that can be lost






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






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






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






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






47. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages






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






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






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