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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Returns on any stock are linearly related to a set of indexes






2. Volatility of unexpected outcomes






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






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






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






6. 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 -






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






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






9. 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






10. 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






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






12. Quantile of an empirical distribution






13. 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






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






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






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






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






18. Asset-liability/market-liquidity risk






19. Market risk - Liquidity risk - Credit risk - Operational risk






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






21. 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






22. 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






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






24. 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






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






26. 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






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






28. 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






29. Hazard - Financial - Operational - Strategic






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






31. 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






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






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






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

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35. Wrong distribution - Historical sample may not apply






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






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






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






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






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






41. 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






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






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






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






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






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






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






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






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






50. Both probability and cost of tail events are considered