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






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






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






4. 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






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






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






7. 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






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






9. 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






10. Wrong distribution - Historical sample may not apply






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






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






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






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






15. Multibeta CAPM Ri - Rf =






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






17. 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






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






19. 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


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






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






22. Asset-liability/market-liquidity risk






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






24. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity






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






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






27. Strategic risk - Business risk - Reputational risk






28. 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






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






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






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






32. Volatility of unexpected outcomes






33. 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 -






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






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






36. Quantile of an empirical distribution






37. Expected value of unfavorable deviations of a random variable from a specified target level






38. 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






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






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






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






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






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






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






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






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






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






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






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






50. Return is linearly related to growth rate in consumption