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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. 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






2. Wrong distribution - Historical sample may not apply






3. 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






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






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






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






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






8. 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






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






10. 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






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






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






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






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

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






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






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






18. Quantile of an empirical distribution






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. Strategic risk - Business risk - Reputational risk






22. Both probability and cost of tail events are considered






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






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






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






26. Changes in vol - implied or actual






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






28. Future price is greater than the spot price






29. Asset-liability/market-liquidity risk






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






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






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






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






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






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






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






37. 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






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






39. 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 -






40. 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






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






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






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






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






45. Interest rate movements - derivatives - defaults






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






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






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






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






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







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