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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. 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






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






3. Future price is greater than the spot price






4. 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






5. 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






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






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






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






9. 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






10. Changes in vol - implied or actual






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






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






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






14. Asset-liability/market-liquidity risk






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






16. Both probability and cost of tail events are considered






17. Rp = XaRa + XbRb






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


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






20. Quantile of a statistical distribution






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






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






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






24. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






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






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






27. 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






28. 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






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






30. Multibeta CAPM Ri - Rf =






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






32. 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.






33. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






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






41. 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 -






42. Volatility of unexpected outcomes






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






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






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






46. 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






47. Quantile of an empirical distribution






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






49. 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






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