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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. Rp = XaRa + XbRb






2. Potential amount that can be lost






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






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






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






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






7. Multibeta CAPM Ri - Rf =






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






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






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






11. Changes in vol - implied or actual






12. Quantile of an empirical distribution






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






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






15. 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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16. Unanticipated movements in relative prices of assets in hedged position






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






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






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






20. 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






21. Future price is greater than the spot price






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






23. 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






24. 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






25. 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






26. 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






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






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






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






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






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






32. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations






33. Hazard - Financial - Operational - Strategic






34. 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






35. 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






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






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






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






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






40. Volatility of unexpected outcomes






41. Quantile of a statistical distribution






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






43. Both probability and cost of tail events are considered






44. 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 -






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






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






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






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






49. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios






50. Strategic risk - Business risk - Reputational risk