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






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






3. Potential amount that can be lost






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






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






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






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






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






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






10. 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






11. Multibeta CAPM Ri - Rf =






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






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






14. Quantile of a statistical distribution






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






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






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






18. Rp = XaRa + XbRb






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






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






21. 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






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






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






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






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






26. 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






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






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






29. Strategic risk - Business risk - Reputational risk






30. 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






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






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






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


34. Volatility of unexpected outcomes






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






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






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






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. 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


40. Hazard - Financial - Operational - Strategic






41. Market risk - Liquidity risk - Credit risk - Operational risk






42. 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






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






44. 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






45. 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






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






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






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






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






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