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FRM: Foundations Of Risk Management

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

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

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

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

5. Wrong distribution - Historical sample may not apply

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

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

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

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

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

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

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

13. Both probability and cost of tail events are considered

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

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

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

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

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

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

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

21. Quantile of a statistical distribution

22. 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

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

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. Probability that a random variable falls below a specified threshold level

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

27. Market risk - Liquidity risk - Credit risk - Operational risk

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

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

30. 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

31. Quantile of an empirical distribution

32. 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

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

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

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

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

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

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

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

41. 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

42. 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

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

44. 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

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

46. 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

47. Interest rate movements - derivatives - defaults

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

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

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