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






2. Asset-liability/market-liquidity risk






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






5. Quantile of an empirical distribution






6. 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






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






8. Market risk - Liquidity risk - Credit risk - Operational risk






9. 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






10. 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 -






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






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






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






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






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






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






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

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






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






20. Interest rate movements - derivatives - defaults






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






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






23. Rp = XaRa + XbRb






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






25. 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






26. Multibeta CAPM Ri - Rf =






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






28. 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






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






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






31. Future price is greater than the spot price






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






33. 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






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






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






36. Quantile of a statistical distribution






37. 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.






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






39. Potential amount that can be lost






40. 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






41. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk






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






43. Hazard - Financial - Operational - Strategic






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






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






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






47. 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






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






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






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







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