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






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






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






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






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






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






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






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






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






11. Multibeta CAPM Ri - Rf =






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






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






14. Future price is greater than the spot price






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






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






17. Interest rate movements - derivatives - defaults






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






19. Quantile of an empirical distribution






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






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






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






23. Hazard - Financial - Operational - Strategic






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






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






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






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






28. Quantile of a statistical distribution






29. 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






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






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






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






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






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






35. 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






36. 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






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






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

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






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






41. Volatility of unexpected outcomes






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






43. 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






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






45. 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






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






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






48. 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






49. 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






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







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