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






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






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






4. 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






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






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






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






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






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






10. 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






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






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






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






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






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






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






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






18. Changes in vol - implied or actual






19. Wrong distribution - Historical sample may not apply






20. Rp = XaRa + XbRb






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






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






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






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






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






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






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






28. Multibeta CAPM Ri - Rf =






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






30. 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






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






32. 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






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






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






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






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






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






38. 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






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






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






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






42. Quantile of an empirical distribution






43. 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






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






45. 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






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






47. 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






48. Strategic risk - Business risk - Reputational risk






49. 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






50. Asset-liability/market-liquidity risk