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






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






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

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4. Both probability and cost of tail events are considered






5. Asses firm risks - Communicate risks - Manage and monitor risks






6. Rp = XaRa + XbRb






7. Volatility of unexpected outcomes






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






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






10. 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






11. Quantile of an empirical distribution






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






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






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






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






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






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






18. Strategic risk - Business risk - Reputational risk






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






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






21. Relative portfolio risk (RRiskp) - Based on a one- month investment period






22. 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






23. 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






24. 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






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






26. 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






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






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






29. 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.






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






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






32. 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






33. Interest rate movements - derivatives - defaults






34. 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






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






36. 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






37. Track an index with a portfolio that excludes certain stocks - Track an index that must include certain stocks - To closely track an index while tailoring the risk exposure






38. 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






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






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






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






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






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






44. 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






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






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






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






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






49. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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