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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. 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






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






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






4. 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






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






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






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






8. Multibeta CAPM Ri - Rf =






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






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






11. 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






12. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






15. 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






16. Wrong distribution - Historical sample may not apply






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






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






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






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






21. 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.






22. Potential amount that can be lost






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






24. 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






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






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






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






28. Strategic risk - Business risk - Reputational risk






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






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






31. 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


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






33. Both probability and cost of tail events are considered






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






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






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






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






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






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






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






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






42. 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






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






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






45. Track an index with a portfolio that excludes certain stocks - Track an index that must include certain stocks - To closely track an index while tailoring the risk exposure






46. 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






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






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






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






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