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






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






3. 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






4. 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






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






6. 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






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






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






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






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






11. Interest rate movements - derivatives - defaults






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






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






14. 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






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






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






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






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






19. Quantile of a statistical distribution






20. 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.






21. 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






22. 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






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






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






25. Changes in vol - implied or actual






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






27. Rp = XaRa + XbRb






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






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






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






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






32. 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






33. 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






34. 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






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






36. Multibeta CAPM Ri - Rf =






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






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






39. Volatility of unexpected outcomes






40. Asset-liability/market-liquidity risk






41. Quantile of an empirical distribution






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






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






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






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






46. 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






47. Wrong distribution - Historical sample may not apply






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






49. 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






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