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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. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks






2. Quantile of an empirical distribution






3. Quantile of a statistical distribution






4. 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






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






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






7. 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






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






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






10. 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






11. Rp = XaRa + XbRb






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






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






14. Return is linearly related to growth rate in consumption






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






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






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






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






19. Hazard - Financial - Operational - Strategic






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






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






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






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






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






25. 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






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






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






28. 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






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






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






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






32. 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






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






34. 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






35. 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






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






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






38. Potential amount that can be lost






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






40. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out






41. Market risk - Liquidity risk - Credit risk - Operational risk






42. Both probability and cost of tail events are considered






43. Asset-liability/market-liquidity risk






44. 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






45. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios






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






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






48. 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






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






50. Volatility of unexpected outcomes