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






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






4. Future price is greater than the spot price






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






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






7. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio






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






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






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






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






12. 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






13. Rp = XaRa + XbRb






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






15. 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






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






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






18. Proportion of loss that is recovered - Also referred to as "cents on the dollar"






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

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20. 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






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






22. 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






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






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






25. 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






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






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






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






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






30. Quantile of an empirical distribution






31. Market risk - Liquidity risk - Credit risk - Operational risk






32. Potential amount that can be lost






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






34. 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






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






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






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






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






39. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






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. 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






42. Strategic risk - Business risk - Reputational risk






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






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






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






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






48. 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






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






50. Wrong distribution - Historical sample may not apply