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






2. 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






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






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






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






6. Rp = XaRa + XbRb






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






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






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






10. 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






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






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






13. Potential amount that can be lost






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






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






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






17. Volatility of unexpected outcomes






18. 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






19. Wrong distribution - Historical sample may not apply






20. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






27. Changes in vol - implied or actual






28. Hazard - Financial - Operational - Strategic






29. 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






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






31. Quantile of an empirical distribution






32. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks






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






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

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






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






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






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






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






40. 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






41. 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 -






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






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






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






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






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






47. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities






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






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






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