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






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






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






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






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






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






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






8. 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






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






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






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






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






13. Wrong distribution - Historical sample may not apply






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






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






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






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






18. Future price is greater than the spot price






19. Asset-liability/market-liquidity risk






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






21. 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 -






22. Volatility of unexpected outcomes






23. Interest rate movements - derivatives - defaults






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






25. Potential amount that can be lost






26. 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






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






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






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






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






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






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






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






34. The lower (closer to - 1) - the higher the payoff from diversification






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






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






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






38. Multibeta CAPM Ri - Rf =






39. 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






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






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






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






43. Changes in vol - implied or actual






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






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






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

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






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






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






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