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






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






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






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






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






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






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






8. Volatility of unexpected outcomes






9. Hazard - Financial - Operational - Strategic






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






11. 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






12. 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






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






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






15. Return is linearly related to growth rate in consumption






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






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






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






19. 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






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






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






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






23. 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






24. Quantile of a statistical distribution






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






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






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






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






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






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






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






32. 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






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






34. Rp = XaRa + XbRb






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






36. 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






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






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






39. Potential amount that can be lost






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






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






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






43. 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






44. Quantile of an empirical distribution






45. 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.






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






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






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






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






50. Interest rate movements - derivatives - defaults