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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 of loses owing to movements in level or volatility of market prices






3. Asset-liability/market-liquidity risk






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






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






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






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






8. 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






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






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






11. Future price is greater than the spot price






12. 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






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






14. Rp = XaRa + XbRb






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






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






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






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






19. Volatility of unexpected outcomes






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






21. 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






22. Country specific - Foreign exchange controls that prohibit counterparty's obligations






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






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






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






26. Potential amount that can be lost






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






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






29. 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






30. 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






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






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






34. Quantile of a statistical distribution






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






36. 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.






37. Market risk - Liquidity risk - Credit risk - Operational risk






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






39. 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






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






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






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






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






44. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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