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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. 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






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






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






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






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






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






7. 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






8. 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






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






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






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






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






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






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






15. Market risk - Liquidity risk - Credit risk - Operational risk






16. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






17. Rp = XaRa + XbRb






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






19. Return is linearly related to growth rate in consumption






20. Both probability and cost of tail events are considered






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






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

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






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






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






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






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






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






29. 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






30. Potential amount that can be lost






31. 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






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






33. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






34. 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






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






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






37. Asset-liability/market-liquidity risk






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






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






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






41. 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






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






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






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






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






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






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






48. Strategic risk - Business risk - Reputational risk






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






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