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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Law of one price - Homogeneous expectations - Security returns process






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






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






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






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






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






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






8. 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






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






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






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






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






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






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






15. Losses due to market activities ex. Interest rate changes or defaults






16. Potential amount that can be lost






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






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






19. Multibeta CAPM Ri - Rf =






20. Hazard - Financial - Operational - Strategic






21. Both probability and cost of tail events are considered






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






23. 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






24. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)

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






26. 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






27. Volatility of unexpected outcomes






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






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






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






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






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






33. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






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






35. 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






36. Changes in vol - implied or actual






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






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






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






40. Future price is greater than the spot price






41. Interest rate movements - derivatives - defaults






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






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






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






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






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






47. Strategic risk - Business risk - Reputational risk






48. 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






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






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







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