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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. 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






2. Wrong distribution - Historical sample may not apply






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






4. 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.






5. Both probability and cost of tail events are considered






6. Quantile of an empirical distribution






7. 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






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






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






10. 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






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






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






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






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






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






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






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


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






19. 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






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






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






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






23. 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






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






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






26. 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






27. 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


28. 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






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






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






31. 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






32. Interest rate movements - derivatives - defaults






33. 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






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






35. Future price is greater than the spot price






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






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






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






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






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






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






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






43. Changes in vol - implied or actual






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






45. Multibeta CAPM Ri - Rf =






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






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






48. Potential amount that can be lost






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






50. Strategic risk - Business risk - Reputational risk