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






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






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






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






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






6. 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






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






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






9. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






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






11. 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






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






13. Wrong distribution - Historical sample may not apply






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






15. Multibeta CAPM Ri - Rf =






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






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






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






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






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

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






22. Both probability and cost of tail events are considered






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






24. 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






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






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






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






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






29. 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






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






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






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






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






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






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






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






37. Volatility of unexpected outcomes






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






39. Changes in vol - implied or actual






40. 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






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






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






43. 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






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






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






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






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






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






50. Hazard - Financial - Operational - Strategic







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