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






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






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






4. 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






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






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






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






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






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






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






11. Changes in vol - implied or actual






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






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






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






15. 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






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






17. 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






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






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






20. 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






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






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






23. 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






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






25. Potential amount that can be lost






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






27. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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






29. Both probability and cost of tail events are considered






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

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






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






33. Hazard - Financial - Operational - Strategic






34. Return is linearly related to growth rate in consumption






35. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






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






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






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






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






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






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






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






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






44. Interest rate movements - derivatives - defaults






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






46. 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






47. Volatility of unexpected outcomes






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






49. Multibeta CAPM Ri - Rf =






50. Asset-liability/market-liquidity risk