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






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






3. 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






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






5. Both probability and cost of tail events are considered






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






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






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. Unanticipated movements in relative prices of assets in hedged position






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






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






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






14. Changes in vol - implied or actual






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






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






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






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






19. Concentrate on mid- region of probability distribution - Relevant to owners and proxies






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






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






22. 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






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






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






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






26. Hazard - Financial - Operational - Strategic






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






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






29. 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 -






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






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






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






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






34. Asset-liability/market-liquidity risk






35. Quantile of an empirical distribution






36. Returns on any stock are linearly related to a set of indexes






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






38. Strategic risk - Business risk - Reputational risk






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






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






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






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






44. Return is linearly related to growth rate in consumption






45. 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






46. Multibeta CAPM Ri - Rf =






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






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






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






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







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