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






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






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






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






5. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)

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






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






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






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






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






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






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






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






15. Asset-liability/market-liquidity risk






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






17. 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






18. Quantile of an empirical distribution






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






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






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






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






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






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






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






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






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






28. Return is linearly related to growth rate in consumption






29. 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






30. 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






31. 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






32. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






38. Wrong distribution - Historical sample may not apply






39. Need to assess risk and tell management so they can determine which risks to take on






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






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






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






43. 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






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






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






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






47. 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






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






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. Strategic risk - Business risk - Reputational risk