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






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






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






4. CAPM requires the strong form of the Efficient Market Hypothesis = private information






5. 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






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






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






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






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






10. 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






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






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






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






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






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






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






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






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






19. 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






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






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






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






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






24. Multibeta CAPM Ri - Rf =






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






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






27. 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






28. Inability to make payment obligations (ex. Margin calls)






29. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






30. Wrong distribution - Historical sample may not apply






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






32. 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






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






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






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






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






38. 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






39. Both probability and cost of tail events are considered






40. 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






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






42. Return is linearly related to growth rate in consumption






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






44. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






45. Changes in vol - implied or actual






46. Interest rate movements - derivatives - defaults






47. Future price is greater than the spot price






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






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






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







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