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






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






3. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






7. Wrong distribution - Historical sample may not apply






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






9. 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






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






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






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






13. 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






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






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






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






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






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






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






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






21. 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






22. Potential amount that can be lost






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






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






25. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






32. 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






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






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






35. 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






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






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






38. 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






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






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






41. Both probability and cost of tail events are considered






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






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






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






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






46. Return is linearly related to growth rate in consumption






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






48. Future price is greater than the spot price






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






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