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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. 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






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






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






4. 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






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






6. Asset-liability/market-liquidity risk






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






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






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






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






11. Multibeta CAPM Ri - Rf =






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






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






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






15. 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






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






17. Interest rate movements - derivatives - defaults






18. Changes in vol - implied or actual






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

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20. Prices of risk are common factors and do not change - Sensitivities can change






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






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






23. 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






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






25. 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






26. 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






27. Wrong distribution - Historical sample may not apply






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






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






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






33. 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






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






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. Absolute and relative risk - direction and non-directional






37. Rp = XaRa + XbRb






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






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






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






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






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






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






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






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






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






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






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






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






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