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FRM: Foundations Of Risk Management

  • Answer 50 questions in 15 minutes.
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  • Match each statement with the correct term.
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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. Concave function that extends from minimum variance portfolio to maximum return portfolio

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

3. 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

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

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

6. Quantile of an empirical distribution

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

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. Volatility of unexpected outcomes

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

11. 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

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

13. 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

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

15. 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

16. The need to hedge against risks - for firms need to speculate.

17. 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

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

19. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized

20. Return is linearly related to growth rate in consumption

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

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

23. 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

24. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk

25. Firms became multinational - - >watched xchange rates more - deregulation and globalization

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

27. Multibeta CAPM Ri - Rf =

28. Market risk - Liquidity risk - Credit risk - Operational risk

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

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

31. Interest rate movements - derivatives - defaults

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

33. 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

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

35. 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

36. Strategic risk - Business risk - Reputational risk

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

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

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

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

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

42. Quantile of a statistical distribution

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

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

45. Rp = XaRa + XbRb

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

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

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

49. Potential amount that can be lost

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