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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. Hazard - Financial - Operational - Strategic






2. Future price is greater than the spot price






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






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






5. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






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






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






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






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






10. Rp = XaRa + XbRb






11. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio






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


13. Wrong distribution - Historical sample may not apply






14. 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






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






16. 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






17. Changes in vol - implied or actual






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






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






20. Asset-liability/market-liquidity risk






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






22. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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






24. Potential amount that can be lost






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






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






27. 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






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






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






30. 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






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






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






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






34. Volatility of unexpected outcomes






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






36. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






37. 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






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






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






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






41. 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






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






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






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






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






46. 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






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






48. 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 -






49. Both probability and cost of tail events are considered






50. 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.