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FRM: Foundations Of Risk Management

  • Answer 50 questions in 15 minutes.
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  • Match each statement with the correct term.
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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. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)

2. 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

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

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

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

6. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation

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

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

9. Concave function that extends from minimum variance portfolio to maximum return portfolio

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

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

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

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

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

15. 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

16. Wrong distribution - Historical sample may not apply

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

18. 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

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

20. Market risk - Liquidity risk - Credit risk - Operational risk

21. 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

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

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

24. 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

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

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

27. The uses of debt to fall into a lower tax rate

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

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

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

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

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

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

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

35. 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

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

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

38. 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

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

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

41. Quantile of a statistical distribution

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

43. Strategic risk - Business risk - Reputational risk

44. Concentrate on mid- region of probability distribution - Relevant to owners and proxies

45. Multibeta CAPM Ri - Rf =

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

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

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

49. Losses due to market activities ex. Interest rate changes or defaults

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