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






2. 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






3. 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






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






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






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






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






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






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






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






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






12. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






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






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






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






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






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






18. Hazard - Financial - Operational - Strategic






19. 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.






20. 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 -






21. 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






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






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






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






25. 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






26. Rp = XaRa + XbRb






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

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






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






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






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






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






33. Potential amount that can be lost






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






35. 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






36. 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






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






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






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






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






41. Both probability and cost of tail events are considered






42. 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






43. Quantile of an empirical distribution






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






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






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






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






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






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






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