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






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






3. 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






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






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






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






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






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






9. Changes in vol - implied or actual






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






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






12. 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






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






14. Return is linearly related to growth rate in consumption






15. Rp = XaRa + XbRb






16. 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






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






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






19. 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






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






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






22. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






25. Potential amount that can be lost






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

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






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






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






30. Wrong distribution - Historical sample may not apply






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






32. 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






33. Multibeta CAPM Ri - Rf =






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






35. 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






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






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






38. Quantile of an empirical distribution






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






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






41. Future price is greater than the spot price






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






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






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






45. 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






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






47. 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.






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






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






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







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