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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. Rp = XaRa + XbRb






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






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






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






5. 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






6. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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7. Probability that a random variable falls below a specified threshold level






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






9. 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.






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






11. 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






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






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






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






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






16. Interest rate movements - derivatives - defaults






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






18. Strategic risk - Business risk - Reputational risk






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






20. Multibeta CAPM Ri - Rf =






21. Covariance = correlation coefficient std dev(a) std dev(b)






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






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






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






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






26. 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






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






28. Changes in vol - implied or actual






29. Relative portfolio risk (RRiskp) - Based on a one- month investment period






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






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






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






33. Quantile of an empirical distribution






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






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






36. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






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






38. 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






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






40. Asset-liability/market-liquidity risk






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






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






43. 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






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






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






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






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






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






49. 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






50. 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