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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. Potential amount that can be lost






2. 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






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






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






5. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






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






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






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






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






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






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






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






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






14. Market risk - Liquidity risk - Credit risk - Operational risk






15. Return is linearly related to growth rate in consumption






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






18. 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 -






19. 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






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






21. Wrong distribution - Historical sample may not apply






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






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






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






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






26. 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






27. 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






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






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






30. Rp = XaRa + XbRb






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






32. Asset-liability/market-liquidity risk






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






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






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






36. 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






37. Multibeta CAPM Ri - Rf =






38. 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






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






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






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






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






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






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






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






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






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






48. Quantile of a statistical distribution






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






50. 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