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






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






3. Volatility of unexpected outcomes






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






5. Asset-liability/market-liquidity risk






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






7. Potential amount that can be lost






8. Market risk - Liquidity risk - Credit risk - Operational risk






9. Future price is greater than the spot price






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






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






12. Changes in vol - implied or actual






13. Hazard - Financial - Operational - Strategic






14. 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






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






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






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






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






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






20. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






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






22. 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






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






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






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






26. 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






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






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


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






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






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






32. 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






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






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






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






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






37. Quantile of a statistical distribution






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






39. 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






40. 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 -






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






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






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






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






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






46. Wrong distribution - Historical sample may not apply






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. 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






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






50. Both probability and cost of tail events are considered