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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. Absolute and relative risk - direction and non-directional






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






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






4. 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






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






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






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






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






9. 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






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






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






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






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






14. Interest rate movements - derivatives - defaults






15. 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






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






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






18. Cannot exit position in market due to size of the position






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






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






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






22. Wrong distribution - Historical sample may not apply






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






24. Volatility of unexpected outcomes






25. Designate ERM champion - usually CRO - Make ERM part of firm culture - Determining all possible risks - Quantifying operational and strategic risks - Integrating risks (dependencies) - Lack of risk transfer mechanisms - Monitoring






26. Potential amount that can be lost






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






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






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






30. Multibeta CAPM Ri - Rf =






31. 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






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






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






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






35. 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


36. 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






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






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. Quantile of an empirical distribution






40. 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






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






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






43. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






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






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






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






47. Rp = XaRa + XbRb






48. Strategic risk - Business risk - Reputational risk






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






50. Market risk - Liquidity risk - Credit risk - Operational risk