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






2. Quantile of an empirical distribution






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






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






5. Return is linearly related to growth rate in consumption






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






7. Asset-liability/market-liquidity risk






8. Hazard - Financial - Operational - Strategic






9. 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






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






11. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






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






13. Losses due to market activities ex. Interest rate changes or defaults






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






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






16. 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






17. 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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18. 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






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






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






21. Strategic risk - Business risk - Reputational risk






22. 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






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






24. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and






25. Wrong distribution - Historical sample may not apply






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






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






28. Changes in vol - implied or actual






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






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






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






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






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






34. Rp = XaRa + XbRb






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






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






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






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. Absolute and relative risk - direction and non-directional






40. Quantile of a statistical distribution






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






42. 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






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






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






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






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






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






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






49. 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






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