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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. Potential amount that can be lost






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






3. Returns on any stock are linearly related to a set of indexes






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






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






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






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






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






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






10. 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 -






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






12. Changes in vol - implied or actual






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






14. 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






15. 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






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






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






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






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






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






21. 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.






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






23. Both probability and cost of tail events are considered






24. Return is linearly related to growth rate in consumption






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






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






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






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






29. Wrong distribution - Historical sample may not apply






30. 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






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






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






33. Volatility of unexpected outcomes






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






36. 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






37. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






42. 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






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






44. 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






45. 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






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






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






48. Quantile of a statistical distribution






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






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