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






2. Future price is greater than the spot price






3. 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






4. Changes in vol - implied or actual






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






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






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






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






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






11. Both probability and cost of tail events are considered






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






13. 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






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






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






16. Return is linearly related to growth rate in consumption






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






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






19. Interest rate movements - derivatives - defaults






20. 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 -






21. Hazard - Financial - Operational - Strategic






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

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






24. 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






25. 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






26. Potential amount that can be lost






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






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






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






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






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






32. Asset-liability/market-liquidity risk






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






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






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






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






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






38. 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






39. 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






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






41. 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.






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






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






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






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






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






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






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






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






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