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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. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






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






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






4. 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






5. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






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






7. 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






8. Both probability and cost of tail events are considered






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






10. 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






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






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






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






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






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






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






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






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






19. 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






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






21. Changes in vol - implied or actual






22. 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






23. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






26. Multibeta CAPM Ri - Rf =






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






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






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






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






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






33. Rp = XaRa + XbRb






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






35. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and






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






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






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






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






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






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






42. 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 -






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






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






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






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






47. Asset-liability/market-liquidity risk






48. The need to hedge against risks - for firms need to speculate.






49. 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






50. 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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