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






2. 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






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






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






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






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






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






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






9. 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






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






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






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






13. Track an index with a portfolio that excludes certain stocks - Track an index that must include certain stocks - To closely track an index while tailoring the risk exposure






14. 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






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






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






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






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






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






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






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






22. Rp = XaRa + XbRb






23. Asset-liability/market-liquidity risk






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






25. 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 -






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






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






28. 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.






29. Hazard - Financial - Operational - Strategic






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






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






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






33. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






36. Quantile of an empirical distribution






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






38. Returns on any stock are linearly related to a set of indexes






39. 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






40. Volatility of unexpected outcomes






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






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






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






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






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






46. Strategic risk - Business risk - Reputational risk






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






49. Wrong distribution - Historical sample may not apply






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