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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. 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






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






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






4. Quantile of a statistical distribution






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






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






7. Rp = XaRa + XbRb






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






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






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






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






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






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






14. Potential amount that can be lost






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






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






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






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






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






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






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






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






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






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






27. Interest rate movements - derivatives - defaults






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






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






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






31. Changes in vol - implied or actual






32. 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






33. Return is linearly related to growth rate in consumption






34. Quantile of an empirical distribution






35. 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






36. Wrong distribution - Historical sample may not apply






37. 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 -






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






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






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






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






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






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






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






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






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






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






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






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






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