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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. Volatility of unexpected outcomes






2. 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






3. Interest rate movements - derivatives - defaults






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






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






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






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






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






10. Strategic risk - Business risk - Reputational risk






11. Absolute and relative risk - direction and non-directional






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






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






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






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






16. 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






17. Quantile of a statistical distribution






18. Return is linearly related to growth rate in consumption






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






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






21. Asset-liability/market-liquidity risk






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






23. 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






24. Potential amount that can be lost






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






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






27. Rp = XaRa + XbRb






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






43. Changes in vol - implied or actual






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






45. Wrong distribution - Historical sample may not apply






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






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






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

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49. 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






50. 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