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






2. Relative portfolio risk (RRiskp) - Based on a one- month investment period






3. Future price is greater than the spot price






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






5. 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 -






6. Rp = XaRa + XbRb






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






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






9. Changes in vol - implied or actual






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






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






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






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






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






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






16. 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






17. 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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18. The need to hedge against risks - for firms need to speculate.






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






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






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






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






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






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






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






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






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






28. Hazard - Financial - Operational - Strategic






29. 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






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






31. 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






32. 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






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






34. 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






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






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






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






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






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






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






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






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






43. Strategic risk - Business risk - Reputational risk






44. Multibeta CAPM Ri - Rf =






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






46. Quantile of a statistical distribution






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






48. Potential amount that can be lost






49. 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






50. Return is linearly related to growth rate in consumption