FRM I - Foundations of Risk Management
UPDATED ACTUAL Exam Questions and
CORRECT Answers
Shortcomings of risk metrics - CORRECT ANSWER - -May not scale over time
-Historical data may be meaningless
-Not designed to account for catastrophes
-VaR says nothing about losses in excess of VaR
-May not handle sudden illiquidity
Importance of communication for risk managers - CORRECT ANSWER - Need to assess
risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks - CORRECT ANSWER - -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
Ways risk can be mismeasured - CORRECT ANSWER - -Wrong distribution
-Historical sample may not apply
Roles of risk management - CORRECT ANSWER - -Asses firm risks
-Communicate risks
-Manage and monitor risks
Banker's Trust - CORRECT ANSWER - -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
Metallgesellschaft - CORRECT ANSWER - -Sold long-term forward contracts on oil and
hedged with long position in short term futures (stack-and-roll hedge)
-Oil prices dropped, oil futures shifted to contango, needed 1.9 billion rescue package
-Learned importance of liquidity
Contango - CORRECT ANSWER - Future price is greater than the spot price
LTCM - CORRECT ANSWER - -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 illiquidity
-Need for stress tests
Allied Irish Bank - CORRECT ANSWER - -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
Barings - CORRECT ANSWER - -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 trading back office
Drysdale Securities (Chase Manhattan) - CORRECT ANSWER - -Obtained unsecured
borrowing of 300 million by exploiting flaw in computing US government bond collateral
UPDATED ACTUAL Exam Questions and
CORRECT Answers
Shortcomings of risk metrics - CORRECT ANSWER - -May not scale over time
-Historical data may be meaningless
-Not designed to account for catastrophes
-VaR says nothing about losses in excess of VaR
-May not handle sudden illiquidity
Importance of communication for risk managers - CORRECT ANSWER - Need to assess
risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks - CORRECT ANSWER - -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
Ways risk can be mismeasured - CORRECT ANSWER - -Wrong distribution
-Historical sample may not apply
Roles of risk management - CORRECT ANSWER - -Asses firm risks
-Communicate risks
-Manage and monitor risks
Banker's Trust - CORRECT ANSWER - -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
Metallgesellschaft - CORRECT ANSWER - -Sold long-term forward contracts on oil and
hedged with long position in short term futures (stack-and-roll hedge)
-Oil prices dropped, oil futures shifted to contango, needed 1.9 billion rescue package
-Learned importance of liquidity
Contango - CORRECT ANSWER - Future price is greater than the spot price
LTCM - CORRECT ANSWER - -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 illiquidity
-Need for stress tests
Allied Irish Bank - CORRECT ANSWER - -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
Barings - CORRECT ANSWER - -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 trading back office
Drysdale Securities (Chase Manhattan) - CORRECT ANSWER - -Obtained unsecured
borrowing of 300 million by exploiting flaw in computing US government bond collateral
