## Test your basic knowledge |

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

**2. Strategic risk - Business risk - Reputational risk**

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

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

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

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

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

**8. Inability to make payment obligations (ex. Margin calls)**

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

**10. 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**

**11. Quantile of a statistical distribution**

**12. 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**

**13. The need to hedge against risks - for firms need to speculate.**

**14. Probability that a random variable falls below a specified threshold level**

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

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

**17. Future price is greater than the spot price**

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

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

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

**21. Potential amount that can be lost**

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

**23. 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**

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

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

**26. Return is linearly related to growth rate in consumption**

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

**28. 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**

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

**30. Long in options = expecting volatility increase - Short in options = expecting volatility decrease**

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

**32. Probability distribution is unknown (ex. A terrorist attack)**

**33. Rp = XaRa + XbRb**

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

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

**36. 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**

**37. 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**

**38. Multibeta CAPM Ri - Rf =**

**39. Hazard - Financial - Operational - Strategic**

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

**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. Market risk - Liquidity risk - Credit risk - Operational risk**

**43. 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**

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

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

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

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

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

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

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