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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. 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






2. Potential amount that can be lost






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






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






5. Future price is greater than the spot price






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






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






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






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






10. 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






11. Asset-liability/market-liquidity risk






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






13. 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






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






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






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






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






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






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






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






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






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






23. 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






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






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






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






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






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






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






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






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






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






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






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






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






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






38. 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






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






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






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






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






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






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






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






46. 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






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






48. 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






49. Losses due to market activities ex. Interest rate changes or defaults






50. 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