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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. Potential amount that can be lost






2. 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






3. The lower (closer to - 1) - the higher the payoff from diversification






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






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






6. Rp = XaRa + XbRb






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






8. 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






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






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






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






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






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






14. Future price is greater than the spot price






15. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






16. 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






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






18. Both probability and cost of tail events are considered






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

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






21. Asset-liability/market-liquidity risk






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






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






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






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






26. Hazard - Financial - Operational - Strategic






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






28. Interest rate movements - derivatives - defaults






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






30. Quantile of a statistical distribution






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






32. 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






33. Wrong distribution - Historical sample may not apply






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






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






37. Risks that are assumed willingly - to gain a competitive edge or add shareholder value






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






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






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






41. 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






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






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






44. 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






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






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






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






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






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






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