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






2. 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






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






4. 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






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






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






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






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

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9. 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






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






11. Changes in vol - implied or actual






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






13. 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






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






15. Potential amount that can be lost






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






17. 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






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






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






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






21. Both probability and cost of tail events are considered






22. 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






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






24. Quantile of a statistical distribution






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






26. Quantile of an empirical distribution






27. 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






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






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






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






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






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






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






34. 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






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






36. 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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37. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






41. Hazard - Financial - Operational - Strategic






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






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






44. Asset-liability/market-liquidity risk






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






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






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






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






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






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