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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. 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






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






3. Potential amount that can be lost






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






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






6. Losses due to market activities ex. Interest rate changes or defaults






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






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






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






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






11. 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






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






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






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






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






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






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






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






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






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






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






22. 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






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






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






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






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






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






28. Wrong distribution - Historical sample may not apply






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






30. Quantile of a statistical distribution






31. Strategic risk - Business risk - Reputational risk






32. 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






33. 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.






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






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






36. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






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






44. Both probability and cost of tail events are considered






45. Future price is greater than the spot price






46. Unanticipated movements in relative prices of assets in hedged position






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






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






49. Multibeta CAPM Ri - Rf =






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






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