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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. 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






2. Both probability and cost of tail events are considered






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






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






5. Quantile of an empirical distribution






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






7. Quantile of a statistical distribution






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






9. Potential amount that can be lost






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






11. 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






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






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






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






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






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






17. Interest rate movements - derivatives - defaults






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






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






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






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






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






23. 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






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






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






26. 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






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






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






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






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






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






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






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






34. Volatility of unexpected outcomes






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






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






37. Multibeta CAPM Ri - Rf =






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






39. Future price is greater than the spot price






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






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






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






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






44. Asset-liability/market-liquidity risk






45. 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






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






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






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






49. 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






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