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






2. 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.






3. 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






4. Potential amount that can be lost






5. Both probability and cost of tail events are considered






6. 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






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






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






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






10. Changes in vol - implied or actual






11. 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






12. Quantile of a statistical distribution






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






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






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






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






17. 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






18. Interest rate movements - derivatives - defaults






19. 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






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






21. Return is linearly related to growth rate in consumption






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






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






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






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






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






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






28. Asset-liability/market-liquidity risk






29. Cannot exit position in market due to size of the position






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






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






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






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






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






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






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






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






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






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






41. 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






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






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






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






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






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






47. Rp = XaRa + XbRb






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






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






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







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