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






2. 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






3. Asset-liability/market-liquidity risk






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






5. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






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






7. Wrong distribution - Historical sample may not apply






8. 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






9. 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






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






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






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






13. Hazard - Financial - Operational - Strategic






14. Asses firm risks - Communicate risks - Manage and monitor risks






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






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






17. 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






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






19. 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






20. Volatility of unexpected outcomes






21. 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






22. 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.






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






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






26. Interest rate movements - derivatives - defaults






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






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






29. 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






30. Quantile of a statistical distribution






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






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






33. 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






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






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






36. Multibeta CAPM Ri - Rf =






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






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






40. 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






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






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






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






44. 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 -






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






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






47. Quantile of an empirical distribution






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






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






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