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






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






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






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






5. Interest rate movements - derivatives - defaults






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






7. Wrong distribution - Historical sample may not apply






8. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out






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






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






11. 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






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






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






14. 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






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






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






17. Probability distribution is unknown (ex. A terrorist attack)






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






19. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






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






25. 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






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






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






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






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






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






31. 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.






32. Both probability and cost of tail events are considered






33. 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






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






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






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






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






38. Rp = XaRa + XbRb






39. Future price is greater than the spot price






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






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

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






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






44. Quantile of a statistical distribution






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






46. 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






47. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






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






49. 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






50. 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 -







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