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






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






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






4. Both probability and cost of tail events are considered






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






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






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






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






9. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






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






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






12. Interest rate movements - derivatives - defaults






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






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






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






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

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






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






19. 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






20. 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






21. Potential amount that can be lost






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






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






24. 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






25. Volatility of unexpected outcomes






26. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






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






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






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






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






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






32. 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






33. 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






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






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






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






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






39. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection






40. Wrong distribution - Historical sample may not apply






41. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






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






47. 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






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






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






50. Unanticipated movements in relative prices of assets in hedged position







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