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






2. 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 -






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






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






5. 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






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






7. 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






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






9. Multibeta CAPM Ri - Rf =






10. Potential amount that can be lost






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






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






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






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






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






16. 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






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






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






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






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






21. Strategic risk - Business risk - Reputational risk






22. The uses of debt to fall into a lower tax rate






23. 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






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






25. Quantile of an empirical distribution






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






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






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






29. Volatility of unexpected outcomes






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

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32. 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






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






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






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






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






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






38. 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






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






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






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






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






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






44. 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






45. Interest rate movements - derivatives - defaults






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






47. 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






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






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






50. Hazard - Financial - Operational - Strategic







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