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






2. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






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






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






5. 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






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






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






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






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






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






11. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






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






13. 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






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






15. Volatility of unexpected outcomes






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






17. 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






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






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






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






21. 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






22. 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






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






24. 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






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






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






27. Quantile of an empirical distribution






28. Relative portfolio risk (RRiskp) - Based on a one- month investment period






29. Strategic risk - Business risk - Reputational risk






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






31. Multibeta CAPM Ri - Rf =






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






33. 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






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






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






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






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. 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






39. Interest rate movements - derivatives - defaults






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






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






42. 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 -






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






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






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






46. Changes in vol - implied or actual






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






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






49. Return is linearly related to growth rate in consumption






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