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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Modeling approach is typically between statistical analytic models and structural simulation models






2. 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






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






4. Multibeta CAPM Ri - Rf =






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






6. Quantile of a statistical distribution






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






8. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






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






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






11. 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






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






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






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






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






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






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






18. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






23. Wrong distribution - Historical sample may not apply






24. 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






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






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






27. Quantile of an empirical distribution






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






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






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






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






32. Volatility of unexpected outcomes






33. 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






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






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






36. Asset-liability/market-liquidity risk






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






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






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






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

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






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






44. Inability to make payment obligations (ex. Margin calls)






45. 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






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






47. 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






48. 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






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






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