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






2. 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






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






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






5. 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






6. 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






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






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






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






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






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






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






13. Hazard - Financial - Operational - Strategic






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






15. 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






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






17. 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






18. 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






19. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






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






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






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






23. Volatility of unexpected outcomes






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






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






26. Wrong distribution - Historical sample may not apply






27. Future price is greater than the spot price






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






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






30. 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






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






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






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






34. Multibeta CAPM Ri - Rf =






35. 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 -






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






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






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






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






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






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






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






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






44. 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






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






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






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






48. 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






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






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