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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. 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






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






3. Strategic risk - Business risk - Reputational risk






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






5. Potential amount that can be lost






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






7. 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 -






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






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






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






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






12. Return is linearly related to growth rate in consumption






13. Concave function that extends from minimum variance portfolio to maximum return portfolio






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






15. 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






16. 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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






35. 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






36. Asset-liability/market-liquidity risk






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






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






39. Risk of loses owing to movements in level or volatility of market prices






40. Wrong distribution - Historical sample may not apply






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






42. 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






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






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






45. Changes in vol - implied or actual






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






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






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






49. 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.






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