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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. Asset-liability/market-liquidity risk






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






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






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






5. 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






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






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






8. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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9. 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






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






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






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






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






14. 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






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






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






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






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






19. Unanticipated movements in relative prices of assets in hedged position






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






21. Interest rate movements - derivatives - defaults






22. Volatility of unexpected outcomes






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






24. 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






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






26. 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






27. 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






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






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






30. Inability to make payment obligations (ex. Margin calls)






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






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






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

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






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






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






37. Future price is greater than the spot price






38. 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






39. Quantile of an empirical distribution






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






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






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






43. 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






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






45. Strategic risk - Business risk - Reputational risk






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






47. Wrong distribution - Historical sample may not apply






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






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






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