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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. 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






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






3. Curve must be concave - Straight line connecting any two points must be under the curve






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






5. Changes in vol - implied or actual






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






7. 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






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






9. 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






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






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






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






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






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






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






16. Quantile of a statistical distribution






17. 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






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


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






20. Future price is greater than the spot price






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






22. Potential amount that can be lost






23. 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






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






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






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






27. 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






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






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






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






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






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






34. Wrong distribution - Historical sample may not apply






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






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






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






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






39. 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






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






41. 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


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






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






44. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






48. Strategic risk - Business risk - Reputational risk






49. 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






50. Volatility of unexpected outcomes