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






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






3. Wrong distribution - Historical sample may not apply






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






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






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






7. Interest rate movements - derivatives - defaults






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






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






10. Quantile of an empirical distribution






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






12. 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






13. 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






14. 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






15. 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.






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






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






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






19. 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






20. 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






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






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






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






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






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






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






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






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






29. 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






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






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






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






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






34. 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






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






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






37. 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






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






39. When negative taxable income is moved to a different year to offset future or past taxable income






40. Potential amount that can be lost






41. 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






42. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






46. 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






47. Return is linearly related to growth rate in consumption






48. Volatility of unexpected outcomes






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






50. 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







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