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






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






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






4. 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






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. Asset-liability/market-liquidity risk






8. 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






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






10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






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






12. 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






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






14. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks






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






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






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






18. 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






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






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

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






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






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






24. 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 -






25. Potential amount that can be lost






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






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






28. Market risk - Liquidity risk - Credit risk - Operational risk






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






30. Strategic risk - Business risk - Reputational risk






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






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






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






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






35. Return is linearly related to growth rate in consumption






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






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






38. 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






39. 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






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






41. Both probability and cost of tail events are considered






42. 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






43. 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






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






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






46. 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






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






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






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






50. Hazard - Financial - Operational - Strategic