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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. 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






2. Wrong distribution - Historical sample may not apply






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






4. 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






5. Return is linearly related to growth rate in consumption






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






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






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






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






10. Relative portfolio risk (RRiskp) - Based on a one- month investment period






11. 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






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






13. 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






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






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






16. Interest rate movements - derivatives - defaults






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






18. 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






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






20. Changes in vol - implied or actual






21. 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






22. 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






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






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






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






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






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






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






29. Quantile of a statistical distribution






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






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






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






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






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






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






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






37. 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






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






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






40. Asset-liability/market-liquidity risk






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






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






43. 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






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






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






46. 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






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






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. Unanticipated movements in relative prices of assets in hedged position






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