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FRM: Foundations Of Risk Management

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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. 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

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

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

4. Changes in vol - implied or actual

5. 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

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

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

8. Quantile of an empirical distribution

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

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

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

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

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

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

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

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

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

18. 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

19. 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

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

21. Wrong distribution - Historical sample may not apply

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

23. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -

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

25. Hazard - Financial - Operational - Strategic

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

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

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

29. Strategic risk - Business risk - Reputational risk

30. 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

31. 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

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

33. Returns on any stock are linearly related to a set of indexes

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

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

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

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

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

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

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

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

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

44. 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

45. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized

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

47. Multibeta CAPM Ri - Rf =

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

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

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