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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. 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.






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






3. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






8. Volatility of unexpected outcomes






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






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






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






12. Return is linearly related to growth rate in consumption






13. Probability distribution is unknown (ex. A terrorist attack)






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






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






16. 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






17. 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






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






19. Future price is greater than the spot price






20. 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






21. 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






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






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






24. 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






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






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






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






28. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements






29. Interest rate movements - derivatives - defaults






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






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






32. Strategic risk - Business risk - Reputational risk






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






34. 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






35. The uses of debt to fall into a lower tax rate






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






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






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






39. 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






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






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






42. 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






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






44. Rp = XaRa + XbRb






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






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






47. 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






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






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






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