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






2. 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






3. Asset-liability/market-liquidity risk






4. Rp = XaRa + XbRb






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






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






7. Changes in vol - implied or actual






8. 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






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






10. Strategic risk - Business risk - Reputational risk






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






12. Hazard - Financial - Operational - Strategic






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






15. 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






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






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






18. 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 -






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






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






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






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






23. 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






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

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






26. 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






27. 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






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






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






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






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






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






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






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






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






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






37. 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






38. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund






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






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






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






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






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






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






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






46. Interest rate movements - derivatives - defaults






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






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






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






50. 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