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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. Changes in vol - implied or actual






2. 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


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






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






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






6. Quantile of an empirical distribution






7. 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






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






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






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






11. 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 -






12. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






13. 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






14. 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






15. 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






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






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






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






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






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






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






22. Wrong distribution - Historical sample may not apply






23. 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






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






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






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






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






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






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






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






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






32. Strategic risk - Business risk - Reputational risk






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






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






35. Hazard - Financial - Operational - Strategic






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






37. Multibeta CAPM Ri - Rf =






38. 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






39. Rp = XaRa + XbRb






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






41. 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






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






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






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






45. 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






46. 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






47. Return is linearly related to growth rate in consumption






48. Future price is greater than the spot price






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






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