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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. Potential amount that can be lost






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






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






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






5. Wrong distribution - Historical sample may not apply






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






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






8. Volatility of unexpected outcomes






9. 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.






10. 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






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






12. 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 -






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






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

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






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






17. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






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






19. 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






20. 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






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






22. 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






23. Asset-liability/market-liquidity risk






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






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






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






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






28. Quantile of an empirical distribution






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






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






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






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






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






34. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders






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






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






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






38. 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






39. 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






40. Strategic risk - Business risk - Reputational risk






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






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






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






44. 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






45. Rp = XaRa + XbRb






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






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






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






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






50. 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