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






2. Quantile of an empirical distribution






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






4. 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






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






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






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






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






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






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






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






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






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






14. 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






15. 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






16. Volatility of unexpected outcomes






17. Both probability and cost of tail events are considered






18. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






22. 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






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






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






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






26. Return is linearly related to growth rate in consumption






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






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






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






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






31. 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






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






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






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






35. 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






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






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






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






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






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






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






42. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls






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






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






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






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






47. Wrong distribution - Historical sample may not apply






48. Interest rate movements - derivatives - defaults






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






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