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






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






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






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






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






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






7. Hazard - Financial - Operational - Strategic






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






9. Quantile of a statistical distribution






10. 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






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






12. 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






13. Changes in vol - implied or actual






14. 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






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






16. 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






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






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






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






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






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






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






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






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






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






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

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






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






29. 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






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






31. When two payments are exchanged the same day and one party may default after payment is made






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






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






34. 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






35. 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






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






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






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






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






41. Potential amount that can be lost






42. Return is linearly related to growth rate in consumption






43. Interest rate movements - derivatives - defaults






44. Strategic risk - Business risk - Reputational risk






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






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






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






48. Asset-liability/market-liquidity risk






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






50. Future price is greater than the spot price