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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. 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






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






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






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






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






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






7. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






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






9. Changes in vol - implied or actual






10. 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






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






12. Wrong distribution - Historical sample may not apply






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






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






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






16. 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






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






18. 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






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






20. Potential amount that can be lost






21. Quantile of an empirical distribution






22. Strategic risk - Business risk - Reputational risk






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






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






25. 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






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






27. 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






28. 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






29. Volatility of unexpected outcomes






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






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






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






33. 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






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






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






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






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






38. 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






39. Quantile of a statistical distribution






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






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






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






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






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






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






46. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






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






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






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