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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. 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






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






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






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






5. 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






6. Wrong distribution - Historical sample may not apply






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






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






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






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






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






12. 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






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






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






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






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






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






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






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






20. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






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






27. Quantile of an empirical distribution






28. Country specific - Foreign exchange controls that prohibit counterparty's obligations






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






30. 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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31. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






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






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






34. 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.






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






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






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






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






39. Volatility of unexpected outcomes






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






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






42. Both probability and cost of tail events are considered






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






44. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi






45. Interest rate movements - derivatives - defaults






46. Multibeta CAPM Ri - Rf =






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






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






49. Market risk - Liquidity risk - Credit risk - Operational risk






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