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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.
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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. Multibeta CAPM Ri - Rf =






2. Wrong distribution - Historical sample may not apply






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






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






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






7. Both probability and cost of tail events are considered






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






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






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






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






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






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






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






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






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






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






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






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






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






21. Quantile of a statistical distribution






22. 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 -






23. 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






24. 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






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






26. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






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






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






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






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






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






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

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






34. Asset-liability/market-liquidity risk






35. 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






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






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






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






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






40. 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






41. Hazard - Financial - Operational - Strategic






42. 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






43. 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






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






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






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






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






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






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






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







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