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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM






2. 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.






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






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






5. 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






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






7. Quantile of a statistical distribution






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






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






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






12. Market risk - Liquidity risk - Credit risk - Operational risk






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






14. 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






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






16. Interest rate movements - derivatives - defaults






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






18. 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






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






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






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






22. Return is linearly related to growth rate in consumption






23. 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 -






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






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






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






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






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






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






30. 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






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

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32. Quantile of an empirical distribution






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






34. 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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35. Occurs the day when two parties exchange payments same day






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






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






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






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






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






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






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






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






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






45. Future price is greater than the spot price






46. Multibeta CAPM Ri - Rf =






47. 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






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






49. Hazard - Financial - Operational - Strategic






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