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






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






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






4. 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






5. Quantile of a statistical distribution






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






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






8. 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






9. 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






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

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






12. Potential amount that can be lost






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






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






15. Changes in vol - implied or actual






16. 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






17. 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.






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






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






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






21. Return is linearly related to growth rate in consumption






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






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






24. Future price is greater than the spot price






25. Hazard - Financial - Operational - Strategic






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






27. 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






28. CAPM requires the strong form of the Efficient Market Hypothesis = private information






29. Volatility of unexpected outcomes






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






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






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






33. Asset-liability/market-liquidity risk






34. 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






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






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






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






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






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






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






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






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






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






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






46. 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






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






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






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






50. 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