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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. 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






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






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






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






6. 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






7. 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






8. 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






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






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






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






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






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






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






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






16. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






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






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






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






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






21. Asses firm risks - Communicate risks - Manage and monitor risks






22. 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






23. Prices of risk are common factors and do not change - Sensitivities can change






24. 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 -






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

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






27. Multibeta CAPM Ri - Rf =






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






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






30. Losses due to market activities ex. Interest rate changes or defaults






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






32. Quantile of an empirical distribution






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






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






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






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






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






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






39. 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






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






41. Modeling approach is typically between statistical analytic models and structural simulation models






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






43. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






50. 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