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






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






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






4. 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






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






6. 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






7. 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






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






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






10. Future price is greater than the spot price






11. Quantile of an empirical distribution






12. 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






13. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return






14. Interest rate movements - derivatives - defaults






15. 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






16. Both probability and cost of tail events are considered






17. 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






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






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






20. Strategic risk - Business risk - Reputational risk






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






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






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






24. 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






25. Risks that are assumed willingly - to gain a competitive edge or add shareholder value






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






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






28. Quantile of a statistical distribution






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






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






31. 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






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






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






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






37. Hazard - Financial - Operational - Strategic






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






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






40. Multibeta CAPM Ri - Rf =






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






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






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






44. Curve must be concave - Straight line connecting any two points must be under the curve






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






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






47. Asset-liability/market-liquidity risk






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






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






50. Changes in vol - implied or actual






Can you answer 50 questions in 15 minutes?



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