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






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






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






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






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






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






7. 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






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






9. 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 -






10. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






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






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






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






14. 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






15. Future price is greater than the spot price






16. Volatility of unexpected outcomes






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






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






19. 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






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






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






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






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






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






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






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






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






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






29. 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






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






31. 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






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






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






34. Law of one price - Homogeneous expectations - Security returns process






35. 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






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






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






38. Rp = XaRa + XbRb






39. Both probability and cost of tail events are considered






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






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






42. Multibeta CAPM Ri - Rf =






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






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






45. Strategic risk - Business risk - Reputational risk






46. Market risk - Liquidity risk - Credit risk - Operational risk






47. Quantile of an empirical distribution






48. Interest rate movements - derivatives - defaults






49. Asset-liability/market-liquidity risk






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