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






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






3. 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






4. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






5. 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 -






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






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






8. Volatility of unexpected outcomes






9. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






16. 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






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






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






19. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






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






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






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






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






29. Changes in vol - implied or actual






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






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






32. 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






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






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






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






36. Future price is greater than the spot price






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






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






39. 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






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






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






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






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






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






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






46. Multibeta CAPM Ri - Rf =






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






48. Market risk - Liquidity risk - Credit risk - Operational risk






49. 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






50. 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







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