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






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






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






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






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






6. 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






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






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






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






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






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






12. 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






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






14. Quantile of an empirical distribution






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. Quantile of a statistical distribution






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






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






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






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






22. Future price is greater than the spot price






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






24. 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






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






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






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






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






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






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






31. 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






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






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






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






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






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






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






39. Volatility of unexpected outcomes






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






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






42. Asset-liability/market-liquidity risk






43. 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






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






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






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






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






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






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






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

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