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






2. 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






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






4. 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






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






6. 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






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






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






9. Asset-liability/market-liquidity risk






10. 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






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






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






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






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






15. Return is linearly related to growth rate in consumption






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






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






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






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. 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






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






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






23. Probability distribution is unknown (ex. A terrorist attack)






24. 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






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






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






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






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






29. Modeling approach is typically between statistical analytic models and structural simulation models






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






31. 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 -






32. 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.






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






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






35. Changes in vol - implied or actual






36. Rp = XaRa + XbRb






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






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






39. Both probability and cost of tail events are considered






40. 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






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






42. 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






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






44. Potential amount that can be lost






45. Interest rate movements - derivatives - defaults






46. Volatility of unexpected outcomes






47. Quantile of a statistical distribution






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






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






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