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






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






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






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






5. Interest rate movements - derivatives - defaults






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






7. Return is linearly related to growth rate in consumption






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






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






10. Derives value from an underlying asset - rate - or index - Derives value from a security






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






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






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






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






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






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






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






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






19. Strategic risk - Business risk - Reputational risk






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






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






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






23. 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






24. Changes in vol - implied or actual






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






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






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






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






29. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






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






31. 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.






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






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






34. Both probability and cost of tail events are considered






35. 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






36. Expected value of unfavorable deviations of a random variable from a specified target level






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






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






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






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






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






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






44. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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







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