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






2. 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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3. 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






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






5. Rp = XaRa + XbRb






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






7. Changes in vol - implied or actual






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






9. Volatility of unexpected outcomes






10. Quantile of an empirical distribution






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






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






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






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






15. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -






16. Both probability and cost of tail events are considered






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






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






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






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






21. 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






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






23. 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






24. 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






25. Potential amount that can be lost






26. Strategic risk - Business risk - Reputational risk






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






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






29. 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






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






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






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






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






34. Multibeta CAPM Ri - Rf =






35. 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






36. Future price is greater than the spot price






37. Asset-liability/market-liquidity risk






38. Quantile of a statistical distribution






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






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






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






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






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






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






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






46. 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






47. 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






48. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






49. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






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