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






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






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






4. 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






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






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






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






8. Multibeta CAPM Ri - Rf =






9. 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






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






11. Future price is greater than the spot price






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






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






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






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






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






17. Strategic risk - Business risk - Reputational risk






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






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






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






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


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






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






25. Potential amount that can be lost






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






27. Both probability and cost of tail events are considered






28. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






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






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






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






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






33. Law of one price - Homogeneous expectations - Security returns process






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






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






36. Return is linearly related to growth rate in consumption






37. 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






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






39. Rp = XaRa + XbRb






40. 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.






41. 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






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






43. 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 -






44. Quantile of an empirical distribution






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






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






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






48. Market risk - Liquidity risk - Credit risk - Operational risk






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






50. 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