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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. 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 -






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






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






4. 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


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






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






7. 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






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






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






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






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






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






13. 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






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






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






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






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






18. Rp = XaRa + XbRb






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






20. Potential amount that can be lost






21. 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






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






23. 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






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






25. 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.






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






27. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






32. Quantile of a statistical distribution






33. 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






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






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






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






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






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






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






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






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






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






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






44. 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






45. 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






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






47. Future price is greater than the spot price






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






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






50. Volatility of unexpected outcomes