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






2. Return is linearly related to growth rate in consumption






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






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

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






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






7. Multibeta CAPM Ri - Rf =






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






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






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






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






12. Rp = XaRa + XbRb






13. 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






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






15. Both probability and cost of tail events are considered






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






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






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






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






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






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






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






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






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






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






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






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






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






29. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






36. 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






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






38. 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






39. Relative portfolio risk (RRiskp) - Based on a one- month investment period






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






41. 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






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






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






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






45. 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






46. Volatility of unexpected outcomes






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






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






49. 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






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