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






2. Both probability and cost of tail events are considered






3. 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.






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






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






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






7. 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






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






9. Multibeta CAPM Ri - Rf =






10. Potential amount that can be lost






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






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






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






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






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






16. 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






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






18. 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






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






20. Volatility of unexpected outcomes






21. 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






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






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






24. Return is linearly related to growth rate in consumption






25. Interest rate movements - derivatives - defaults






26. 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






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






28. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






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






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






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






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






33. Quantile of an empirical distribution






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






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






36. Quantile of a statistical distribution






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






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






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. 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






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






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






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






44. 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






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






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






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






48. 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






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






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