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






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






3. 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






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






5. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






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






12. Quantile of a statistical distribution






13. 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






14. Hazard - Financial - Operational - Strategic






15. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






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






17. Changes in vol - implied or actual






18. Multibeta CAPM Ri - Rf =






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






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






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






22. 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






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






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






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






26. 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 -






27. 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






28. Interest rate movements - derivatives - defaults






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






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






31. CAPM requires the strong form of the Efficient Market Hypothesis = private information






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






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






34. 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






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






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






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






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






39. Curve must be concave - Straight line connecting any two points must be under the curve






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






41. Market risk - Liquidity risk - Credit risk - Operational risk






42. Future price is greater than the spot price






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






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






45. 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






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






47. 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






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






49. 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






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