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






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






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






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






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






6. 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






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






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






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






10. 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






11. 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 -






12. 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






13. Future price is greater than the spot price






14. Quantile of an empirical distribution






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






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






17. Return is linearly related to growth rate in consumption






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






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






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






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






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






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






24. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






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






26. Quantile of a statistical distribution






27. Market risk - Liquidity risk - Credit risk - Operational risk






28. 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






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






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






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






32. 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






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






34. 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






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






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






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






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






39. 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






40. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






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






48. Both probability and cost of tail events are considered






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






50. Potential amount that can be lost