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






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






3. Asset-liability/market-liquidity risk






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






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






6. Return is linearly related to growth rate in consumption






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






8. 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






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






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






11. 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






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






13. Wrong distribution - Historical sample may not apply






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






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

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16. 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 -






17. 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






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






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






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






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






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






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






24. 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






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






26. Changes in vol - implied or actual






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






28. 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






29. Rp = XaRa + XbRb






30. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






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






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






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






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






35. 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






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






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






38. Hazard - Financial - Operational - Strategic






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






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






41. Unanticipated movements in relative prices of assets in hedged position






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






43. 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






44. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses






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






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






47. Multibeta CAPM Ri - Rf =






48. 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






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






50. 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