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






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






3. Strategic risk - Business risk - Reputational risk






4. 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






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






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






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






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






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






10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






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






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






13. 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






14. 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






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






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






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






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






19. 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






20. 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


21. 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






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






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






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






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






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






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






28. Volatility of unexpected outcomes






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






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






31. Both probability and cost of tail events are considered






32. 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 -






33. Future price is greater than the spot price






34. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






35. 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.






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






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






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






39. Wrong distribution - Historical sample may not apply






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






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






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






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






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






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






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






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






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






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






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