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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. Quantile of an empirical distribution






2. Market risk - Liquidity risk - Credit risk - Operational risk






3. Volatility of unexpected outcomes






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






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






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






7. Law of one price - Homogeneous expectations - Security returns process






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






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






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






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






12. 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






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






14. 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






15. Changes in vol - implied or actual






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






17. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






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






24. 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






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






26. Wrong distribution - Historical sample may not apply






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






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






29. 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






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






31. 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.






32. 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






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






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






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






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






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






38. Asset-liability/market-liquidity risk






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






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. Interest rate movements - derivatives - defaults






42. 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






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






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






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






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






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






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






49. Expected value of unfavorable deviations of a random variable from a specified target level






50. Quantile of a statistical distribution







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