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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. Future price is greater than the spot price






2. Unanticipated movements in relative prices of assets in hedged position






3. 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






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






5. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






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






7. Rp = XaRa + XbRb






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






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






10. 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






11. 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






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






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






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






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






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






17. Changes in vol - implied or actual






18. 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






19. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






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






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






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






23. 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






24. 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






25. 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






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






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






28. 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






29. Volatility of unexpected outcomes






30. Potential amount that can be lost






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






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






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






34. Both probability and cost of tail events are considered






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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