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






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






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






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

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






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






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






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






9. Derives value from an underlying asset - rate - or index - Derives value from a security






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






11. 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






12. Future price is greater than the spot price






13. Quantile of a statistical distribution






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. Hazard - Financial - Operational - Strategic






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






17. Changes in vol - implied or actual






18. Wrong distribution - Historical sample may not apply






19. Asset-liability/market-liquidity risk






20. 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






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






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






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






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






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






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






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






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






30. 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






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






32. 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






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






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






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






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






37. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity






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






39. 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.






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






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






42. 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






43. 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






44. Rp = XaRa + XbRb






45. 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






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






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






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






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






50. Quantile of an empirical distribution