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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Changes in vol - implied or actual






2. Hazard - Financial - Operational - Strategic






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






4. 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






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






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






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






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






9. Quantile of an empirical distribution






10. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






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






12. 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






13. 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






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






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






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






17. Quantile of a statistical distribution






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






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






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






21. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






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






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






24. 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






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






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






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






28. 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






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






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






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






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






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






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






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






37. Asset-liability/market-liquidity risk






38. Rp = XaRa + XbRb






39. 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






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






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






42. Wrong distribution - Historical sample may not apply






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






44. 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






45. Future price is greater than the spot price






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






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






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






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






50. Strategic risk - Business risk - Reputational risk