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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. 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






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






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






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






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






6. 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






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






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






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






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






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






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






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






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






15. 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






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






17. 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






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






19. Quantile of a statistical distribution






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






21. Asset-liability/market-liquidity risk






22. 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






23. 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






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






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

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27. Quantile of an empirical distribution






28. Inability to make payment obligations (ex. Margin calls)






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






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






31. 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






32. Hazard - Financial - Operational - Strategic






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






34. Wrong distribution - Historical sample may not apply






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






36. 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






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






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






39. 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






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






41. Strategic risk - Business risk - Reputational risk






42. 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.






43. 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 -






44. 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






45. Rp = XaRa + XbRb






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






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






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






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






50. 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