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






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






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






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






5. Hazard - Financial - Operational - Strategic






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






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






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






9. Quantile of a statistical distribution






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






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






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






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






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






15. 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






16. Future price is greater than the spot price






17. Wrong distribution - Historical sample may not apply






18. 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






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






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






21. 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






22. 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






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






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






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






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






27. Strategic risk - Business risk - Reputational risk






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






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






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






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






32. 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






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






34. 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






35. Potential amount that can be lost






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






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






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






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






40. 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.






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






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






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






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






45. Market risk - Liquidity risk - Credit risk - Operational risk






46. 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






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






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






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






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







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