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






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






3. Market risk - Liquidity risk - Credit risk - Operational risk






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






5. 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






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






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






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






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






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






11. Hazard - Financial - Operational - Strategic






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






13. 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






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






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






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

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






18. 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






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






20. Return is linearly related to growth rate in consumption






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






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






23. Rp = XaRa + XbRb






24. 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






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






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






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






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






29. Future price is greater than the spot price






30. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






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






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






33. 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






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






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






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






37. 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.






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






39. 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






40. 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






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






42. 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






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






44. Wrong distribution - Historical sample may not apply






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






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






47. Changes in vol - implied or actual






48. Quantile of a statistical distribution






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






50. Curve must be concave - Straight line connecting any two points must be under the curve