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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. 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






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






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






4. 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






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






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






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






8. 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






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






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






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






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






13. 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






14. The uses of debt to fall into a lower tax rate






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






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






17. Both probability and cost of tail events are considered






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






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






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






21. Expected value of unfavorable deviations of a random variable from a specified target level






22. Return is linearly related to growth rate in consumption






23. Changes in vol - implied or actual






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






25. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset






26. Wrong distribution - Historical sample may not apply






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






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






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






30. Hazard - Financial - Operational - Strategic






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






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






33. 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






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






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






36. Potential amount that can be lost






37. Quantile of an empirical distribution






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






39. Market risk - Liquidity risk - Credit risk - Operational risk






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






41. 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






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






43. 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






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






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






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






47. Multibeta CAPM Ri - Rf =






48. 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






49. Future price is greater than the spot price






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