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






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

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






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






5. Occurs the day when two parties exchange payments same day






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






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






8. Future price is greater than the spot price






9. 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






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






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






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






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






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






15. Volatility of unexpected outcomes






16. Both probability and cost of tail events are considered






17. 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






18. 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.






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






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






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






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






23. 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






24. Hazard - Financial - Operational - Strategic






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






26. Potential amount that can be lost






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






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






29. 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






30. Changes in vol - implied or actual






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






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






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






34. 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






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






36. 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 -






37. 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






38. 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






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. Asset-liability/market-liquidity risk






41. 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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42. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






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






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






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






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






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






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






49. Strategic risk - Business risk - Reputational risk






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