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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.
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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. 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 -






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






3. 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






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






5. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






11. 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






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






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






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






15. 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






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






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






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






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






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






22. Volatility of unexpected outcomes






23. Future price is greater than the spot price






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






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






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






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






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






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






30. 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






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






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






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






34. Quantile of a statistical distribution






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






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






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






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






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






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






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






43. Potential amount that can be lost






44. 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






45. 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






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






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






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






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






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







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