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






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






3. Risks that are assumed willingly - to gain a competitive edge or add shareholder value






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






5. 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






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






7. 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






8. 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






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






10. Both probability and cost of tail events are considered






11. 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






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






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






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






15. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






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






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






18. Return is linearly related to growth rate in consumption






19. Rp = XaRa + XbRb






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






21. 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






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






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






24. Future price is greater than the spot price






25. 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 -






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






27. Hazard - Financial - Operational - Strategic






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






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






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






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






32. 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






33. Potential amount that can be lost






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






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






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






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






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






39. 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






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






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


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






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






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






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






46. 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






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






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






49. 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






50. Interest rate movements - derivatives - defaults