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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. Potential amount that can be lost






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






3. 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






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






5. Interest rate movements - derivatives - defaults






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






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






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






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






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






11. Designate ERM champion - usually CRO - Make ERM part of firm culture - Determining all possible risks - Quantifying operational and strategic risks - Integrating risks (dependencies) - Lack of risk transfer mechanisms - Monitoring






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






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






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






15. 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






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






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






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






19. 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






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






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






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






23. 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






24. 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






25. Cannot exit position in market due to size of the position






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






27. 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






28. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






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






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






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






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






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






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






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






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






41. 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






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






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






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






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






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






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






48. Wrong distribution - Historical sample may not apply






49. 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






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