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






2. 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 -






3. Need to assess risk and tell management so they can determine which risks to take on






4. Multibeta CAPM Ri - Rf =






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






6. 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






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






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






9. Changes in vol - implied or actual






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






11. Quantile of a statistical distribution






12. Rp = XaRa + XbRb






13. 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






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






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






16. Strategic risk - Business risk - Reputational risk






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






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






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






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






21. Hazard - Financial - Operational - Strategic






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






23. Return is linearly related to growth rate in consumption






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






25. 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






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






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






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






29. 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






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






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






32. 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






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






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






35. 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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36. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders






37. Volatility of unexpected outcomes






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






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






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






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






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






43. 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






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






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






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






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






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






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






50. 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






Can you answer 50 questions in 15 minutes?



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