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






2. 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






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






4. Return is linearly related to growth rate in consumption






5. 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 -






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






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






8. Potential amount that can be lost






9. 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






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






11. 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






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






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






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






15. 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






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

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






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






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






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






21. 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






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






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






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






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






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






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






28. Multibeta CAPM Ri - Rf =






29. 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






30. 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






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






32. 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






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






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






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






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






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






38. Quantile of an empirical distribution






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






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






41. 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






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






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






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






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






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






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






48. Volatility of unexpected outcomes






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






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