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






2. 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






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






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






5. 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






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






7. Asset-liability/market-liquidity risk






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






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






11. Volatility of unexpected outcomes






12. Wrong distribution - Historical sample may not apply






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






14. Interest rate movements - derivatives - defaults






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






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






17. Hazard - Financial - Operational - Strategic






18. Return is linearly related to growth rate in consumption






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






20. Changes in vol - implied or actual






21. 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






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






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






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






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






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






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






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






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






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






31. 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






32. Asses firm risks - Communicate risks - Manage and monitor risks






33. 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






34. 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






35. Rp = XaRa + XbRb






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






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






38. Quantile of a statistical distribution






39. 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






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






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






42. 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






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






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






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






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






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






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






49. 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






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