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






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






3. Interest rate movements - derivatives - defaults






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






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






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






7. Multibeta CAPM Ri - Rf =






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






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






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






11. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -






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






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






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






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






17. Future price is greater than the spot price






18. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






19. 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






20. 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






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






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






23. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity






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






25. 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.






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






27. 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






28. 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






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






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






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






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






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






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






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






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






37. Asset-liability/market-liquidity risk






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






39. 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






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






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






42. Rp = XaRa + XbRb






43. Quantile of a statistical distribution






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






45. Wrong distribution - Historical sample may not apply






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






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






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






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






50. Quantile of an empirical distribution