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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. Quantile of a statistical distribution






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






3. 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






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






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






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






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






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






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






10. Quantile of an empirical distribution






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






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






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






14. 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






15. 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






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






17. Wrong distribution - Historical sample may not apply






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






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






20. Hazard - Financial - Operational - Strategic






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






22. 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






23. Future price is greater than the spot price






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






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






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






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






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






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






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






31. Curve must be concave - Straight line connecting any two points must be under the curve






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






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






34. 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






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






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






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






38. 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






39. Potential amount that can be lost






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


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






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






43. Both probability and cost of tail events are considered






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






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






46. 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






47. Interest rate movements - derivatives - defaults






48. 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






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






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