GARP FRM® Exam Sample Questions and Answers

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FRM Examination Tips

In preparing for the FRM Examinations, we encourage students to plan ahead so that no time will be wasted in
trying to cover all necessary areas before exam day and that adequate time will be available for practicing questions

Make a special note of the sectional percentage weightings and plan accordingly

In addition to this, spend a bit more time on your weaker subject areas to better understand the essential concepts
and practice more questions surrounding these problematic topics

Please use the following information only as a general guide

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Sample Questions & Answers

FRM Part I

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

Of the following statements, select the one(s) that is (are) most likely true with regards to a loan portfolio:

i) Lowering the recovery rate + Increasing the default probability = an increase expected loss
ii) Increasing the recovery rate + Increasing the default probability = an increase expected loss
iii) Lowering the recovery rate + Lowering the default probability = an increase expected loss

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) i, ii and iii

ANSWER

All three will result in an increase in expected loss!

Lowering the recovery rate + Increasing the default probability = an increase expected loss
Increasing the recovery rate + Increasing the default probability = an increase expected loss
Lowering the recovery rate + Lowering the default probability = an increase expected loss

Thus, the correct answer is F.

Note:

Increasing the recovery rate + Decreasing the default probability will result in a decrease in the expected
loss.

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

Which of the following, if any, are true?

i) Value-at-Risk, VaR, is not a measure of downside risk

ii) Value-at-Risk, VaR, is the minimum loss at a given confidence level over a given period of time

iii) Value-at-Risk, VaR, does not capture catastrophic losses that have a small probability of occurring

A) i only
B) i and ii only
C) i and iii only
D) ii and iii only
E) iii only
F) None of the above

ANSWER

Remember, we are being asked to determine the options that are true.

Value-at-Risk, VaR, is a measure of downside risk. It may also be considered as the maximum loss at a
given confidence level over a given period of time.

VaR, does not capture catastrophic losses that have a small probability of occurring.

It is also true that since most firms are more concerned about unexpected loss, the frequently used risk
measure is Value-at-Risk.

Daily VaR becomes meaningless if there is illiquidity

Thus, the correct answer is E.

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

You are being asked to consider the following statement:

A comprehensive and integrated framework for managing keys risks achieving business objectives,
minimizing unexpected earnings volatility and maximizing firm value.

This statement may be described as one that is addressing:

A) Trading Risk Management

B) Enterprise Risk Management
C) Systematic Risk Management
D) Unsystematic Risk Management
E) Volatility Risk Management
F) None of the above

ANSWER

Enterprise Risk Management (ERM) is a comprehensive and integrated framework for managing keys risks
in order to achieve business objectives, minimize unexpected earnings volatility and maximize firm value.

Thus, the correct answer is B.

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

From your knowledge of arbitrage opportunities select which of the following are false:

i) Riskless profits can be made with arbitrage

ii) Trades are essentially made simultaneously
iii) Arbitrageurs aren’t required to have capital
iv) Arbitrage involves the simultaneous buying and selling of securities, currency, or commodities in
different markets or in derivative forms in order to take advantage of differing prices for the same asset.

A) i and ii only
B) ii and iii only
C) i, ii and iv only
D) i and iv only
E) i, ii and iii only
F) None of the above

ANSWER

Remember, you are being asked to select the false answer(s). And it is true that:

 Riskless profits can be made with arbitrage

 Trades are essentially made simultaneously
 Arbitrageurs aren’t required to have capital

Thus, the correct answer is F.

By definition: Arbitrage involves the simultaneous buying and selling of securities, currency, or
commodities in different markets or in derivative forms in order to take advantage of differing prices for
the same asset.

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

Of the presented options below, which, if any, would you say is/are the most accurate statement/s?

i) The capital market line can only be applied to portfolios that don’t carry unsystematic risk.

ii) The capital allocation line can only be applied to portfolios that don’t carry unsystematic risk.

iii) The capital market line can be applied to an investor’s individual assets

iv) The capital allocation line can be applied to an investor’s individual assets

A) ii only
B) i and iii only
C) ii only and iv only
D) ii and iii only
E) i and iv only
F) i and ii only

ANSWER

Remember, you are being asked to find the most accurate statement/s.

The capital market line (CML) is a line used in the capital asset pricing model to illustrate the rates of
return for efficient portfolios depending on the risk-free rate of return and the level of risk (standard
deviation) for a particular portfolio. The CML can only be applied to efficient portfolios (i.e. no
unsystematic risk) and not to an investor’s individual assets.

The capital allocation line (CAL) is a line created in a graph of all possible combinations of risky and risk-
free assets. Also known as the "reward-to-variability ratio". The CAL can only be applied to efficient
portfolios (i.e. no unsystematic risk) and not to an investor’s individual assets.

Thus, the correct answer is F.

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Sample From: Foundations of Risk Management

Level: FRM Part I

QUESTION

If you are told that the daily, 90% confidence level, value at risk of a portfolio is $100,000, then you would
anticipate that:

i) 9 out of 10 times, the value of the portfolio will lose more than $100,000.
ii) 1 out of 10 times, we would expect the portfolio to lose $100,000 or less.
iii) 9 out of 10 times, the value of the portfolio will lose less than $100,000.
iv) 1 out of 10 times, we would expect the portfolio to lose $100,000 or more.

A) i only
B) ii only
C) iii only
D) i and ii only
E) iii and iv only
F) iv only

ANSWER

We are told that the daily, 90% confidence level, value at risk of a portfolio is $1,000,000. Hence, we
would expect that:

9 out of 10 times (i.e. 90% of the time) the value of the portfolio will lose less than $100,000.

Put another way; 1 times out of 10 (i.e. 10% of the time), we would expect the portfolio to lose $100,000
or more.

Thus, the correct answer is E.

Value-at-Risk, VaR, is a measure of downside risk. It may also be considered as the maximum loss at a
given confidence level over a given period of time.

VaR, does not capture catastrophic losses that have a small probability of occurring.

It is also true that since most firms are more concerned about unexpected loss, the frequently used risk
measure is Value-at-Risk.

Daily VaR becomes meaningless if there is illiquidity

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

Consider your knowledge of Value-at-Risk ( VaR ) and select the statements that are most likely true.

i) Value-at-Risk will increase once holdings periods become longer

ii) Value-at-Risk will decrease once probability levels become lower
iii) Value-at-Risk cannot be calculated by using the historical returns of a portfolio

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following is considered to be correct:

 Value-at-Risk will increase once holdings periods become longer

 Value-at-Risk will increase once probability levels become lower
 Value-at-Risk can be calculated by using the historical returns of a portfolio

Thus, the correct answer is A.

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

Consider your knowledge of the Student’s t-Distribution and select the most accurate statements below:

i) The Student’s t-Distribution’s shape will become less similar to that of a Standard Normal Distribution as
the Degrees of Freedom increases
ii) The Student’s t-Distribution’s shape is considered to be less-peaked compared to a Normal Distribution
iii) The Student’s t-Distribution’s has a greater area under its tails compared to a Normal Distribution
iv) There are three factors to choose from when selecting the appropriate Distribution: 1) Whether the
Population Variance is Known, 2) Whether the Distribution is Normal and 3) What is the Sample Size

A) i and ii only
B) i and iii only
C) i, ii and iii only
D) i, ii and iv only
E) i, iii and iv only
F) ii, iii and iv only
G) i, ii, iii and iv
H) None of the above

ANSWER

The following are considered to be correct:

 The Student’s t-Distribution’s shape will become more similar to that of a Standard Normal
Distribution as the Degrees of Freedom increases
 The Student’s t-Distribution’s shape is considered to be less-peaked compared to a Normal
Distribution
 The Student’s t-Distribution’s has a greater area under its tails compared to a Normal Distribution
 There are three factors to choose from when selecting the appropriate Distribution: 1) Whether
the Population Variance is Known, 2) Whether the Distribution is Normal and 3) What is the
Sample Size

Thus, the correct answer is F.

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

Consider your knowledge of Regression Analysis.

From your knowledge, determine which of the following is (are) most likely correct:

i) Having Positive Serial Correlation will result in t-values becoming larger

ii) Having a Negative Serial Correlation will happen once a -ve Error in one given observation increase the
probability of a +ve Error occurring for another

iii) Type-II Errors may be developed as a result of having Positive Serial Correlation

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Having Positive Serial Correlation will result in t-values becoming larger

 Having a Negative Serial Correlation will happen once a +ve Error in one given observation
increase the probability of a –ve Error occurring for another

 Type-I Errors may be developed as a result of having Positive Serial Correlation

Thus, the correct answer is A.

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

You are being asked to determine whether one particular stock that is trading frequently on the market is
of a greater volatility than another given stock that also trades frequently. As a result of this request, you
collect data on both securities, using their respective prices to create their Sample Variance.

Under these circumstances, determine which of the following would be considered as the most
appropriate means to conduct such a testing.

A) The F-Test
B) The t-Test
C) The q-Test
D) The Z-Test
E) The Chi Square Test
F) The Binomial Test
G) Unable to determine from given information

ANSWER

We will utilize the ‘ F-Test ‘ in testing dissimilarity of two samples’ variance.

Thus, the correct answer is A.

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

From the following given options, determine those that may be classified as ‘linear‘ or even ‘near linear‘.

i) Swaps
ii) Forwards
iii) Futures
iv) Options

A) i and ii only
B) i and iii only
C) i, ii and iii only
D) i, ii and iv only
E) i, iii and iv only
F) ii, iii and iv only
G) i, ii, iii and iv
H) None of the above

ANSWER

The following are considered to be linear ( or near linear ):

 Swaps
 Forwards
 Futures

Thus, the correct answer is C.

Please note that Options are typically non-linear.

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Sample From: Quantitative Analysis

Level: FRM Part I

QUESTION

Consider your knowledge of the Central Limit Theorem.

Assuming that the Population Variance is not known and the size of the sample taken is 31, an
appropriate test for determining the Sample Mean will be:

i) The t-test
ii) The z-test
iii) The f-test

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

Assuming that the Population Variance is not known and the size of the sample taken is 31, an
appropriate test for determining the Sample Mean will be:

 The t-test OR the Z-test

Thus, the correct answer is D.

We Note:

 According to the Central Limit Theorem, the z-test may be employed if the population is
sufficiently large ( i.e. n ≥ 30 ), even if the Variance is unknown
 As the size of the sample gets larger, both t- and z- distributions will converge ( so either test will
suffice )
 Nevertheless, the t-test will be considered a more conservative estimation

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Sample From: Financial Markets and Products

Level: FRM Part I

QUESTION

Determine which of the following options below may be considered as reasons for causing a yield curve to
slope upwards.

i) Expectations of higher inflation rates

ii) Expectations of higher interest rates
iii) Expectations of improving outlook for credit risk
iv) Investors favoring maturities with short terms

A) i and ii only
B) i and iii only
C) i, ii and iii only
D) i, ii and iv only
E) i, iii and iv only
F) ii, iii and iv only
G) i, ii, iii and iv

ANSWER

The following may be considered as reasons for causing a yield curve to slope upwards:

 Expectations of higher inflation rates

 Expectations of higher interest rates
 Expectations of improving outlook for credit risk
 Investors favouring maturities with short terms

Thus, the correct answer is G.

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Sample From: Financial Markets and Products

Level: FRM Part I

QUESTION

Consider your knowledge of FRAs (Forward-Rate-Agreements).

Of the given options presented below, select that which is mostly likely correct:

A) A Forward-Rate-Agreement will not settle in cash. It will have interest rate risk only. FRAs may
employed to hedge risks regarding uncertainty around receiving payments from a (floating-rate) loan.

B) A Forward-Rate-Agreement will settle in cash. It will have both interest rate risk as well as default risk.
FRAs may not be used to hedge risks regarding uncertainty around receiving payments from a (fixed-rate)
loan.

C) A Forward-Rate-Agreement will settle in cash. It will have both interest rate risk as well as default risk.
FRAs may employed to hedge risks regarding uncertainty around receiving payments from a (floating-
rate) loan.

D) A Forward-Rate-Agreement will not normally settle in cash. It will have default risk only. FRAs may
employed to hedge risks regarding uncertainty around receiving payments from a (fixed-rate) loan.

E) A Forward-Rate-Agreement will not settle in cash. It will have both interest rate risk as well as default
risk. FRAs may employed to hedge risks regarding uncertainty around receiving payments from a (floating-
rate) loan.

F) A Forward-Rate-Agreement will settle in cash. It will have both interest rate risk only. FRAs may be
employed to hedge risks regarding uncertainty around receiving payments from a (fixed-rate) loan.

ANSWER

A Forward-Rate-Agreement will settle in cash. It will have both interest rate risk as well as default risk.
FRAs may employed to hedge risks regarding uncertainty around receiving payments from a (floating-
rate) loan.

Thus, the correct answer is C.

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Sample From: Financial Markets and Products

Level: FRM Part I

QUESTION

Consider the scenario of a pension fund that owns a portfolio of bonds (fixed rate in nature).

You are told that the duration of the portfolio is 4 years however the duration of the liabilities of the
pension fund amounts to 8 years.

If the fund manager thinks that interest rates will have a good chance of dropping within the next few
months, which of the following strategies will he want to pursue to nullify the duration disparity?

A) Participate in a swap, receiving fixed while paying floating.

B) Participate in a swap, receiving floating while paying fixed.
C) Participate in a swap, receiving fixed while paying fixed.
D) Sell USD futures contracts
E) Sell GBP futures contracts
F) None of the above

ANSWER

In this example, we are faced with a fund that has the duration of its liabilities exceeding that its assets
(i.e. their investment portfolio). As a result, if interest rates go down, then the fund’s liabilities will
continue to overshadow their assets, making the situation worse.

Remember: A swap’s duration will be the difference in the duration of the fixed and the duration of the
floating.

Knowing this, by participating in a swap that will receive fixed the fund can then have its portfolio
duration increased up to the point where it is even equal to its liabilities, thereby reducing the risk of
interest rates going down.

If we entered a pay fixed, such an action will lower the assets’ duration (making the situation worse when
rates go down).

If we sold futures, this action will also lower the portfolio’s duration (and increase the present duration
mis-match).

Thus, the correct answer is A.

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Sample From: Financial Markets and Products

Level: FRM Part I

QUESTION

Consider your knowledge of option strategies.

Of the following given options, select the ones that are most likely correct.

i) The strategy of purchasing both a put & call with strike prices that are different is known as a “long
strangle”

ii) A “vertical spread” is a term synonymous with having strike prices that are different.

iii) The strategy of selling a call at a relatively lower strike price & buying a call at a relatively higher strike
price is known as a “short bull”

A) i only
B) ii only
C) iii only
D) i and ii only
E) ii and iii only
F) i, ii, and iii

ANSWER

The following are correct:

 The strategy of purchasing both a put & call with strike prices that are different is known as a “long
strangle”

 A “vertical spread” is a term synonymous with having strike prices that are different.

 The strategy of selling a call at a relatively lower strike price & buying a call at a relatively higher strike
price is known as a “short bull”

Thus, the correct answer is F.

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Sample From: Valuation and Risk Models

Level: FRM Part I

QUESTION

You are told that an investment manager sold 500 call-option contracts each on 300 share units within
Firm X, having a 60-day maturity at a price of $3.00.

Assuming that the option’s delta on a single share unit is 0.42, determine the most appropriate action
necessary towards the firm’s shares so as to achieve a hedge of the option’s exposure and have it remain
delta-neutral.

A) 15,000 shares to be sold

B) 15,000 shares to be bought
C) 19,500 shares to be sold
D) 19,500 shares to be bought
E) 25,200 shares to be sold
F) 25,200 shares to be bought
G) Unable to determine from given information

ANSWER

Firstly, determining the actual number of calls for the given sale action:

# of Calls = ( 200 contracts ) X ( 300 units )

= 60,000 calls

As a result, this amount has to be hedged by: 60,000 X 0.42 = 25,200 share units

Meaning, 25,200 shares will have to be purchased to keep a delta-neutral position.

Thus, the correct answer is F.

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Sample From: Valuation and Risk Models

Level: FRM Part I

QUESTION

Consider your knowledge how the price of an option varies with the change in price of the underlying
security and determine which of the following statements is correct:

A) Gamma will be at its lowest ( i.e. when delta is the most sensitive ) for short term options that are at-
the-money. Gamma will be the same for both calls as well as puts in the Black Scholes pricing
environment

B) Gamma will be at its highest ( i.e. when delta is the least sensitive ) for short term options that are in-
the-money. Gamma will be the same for both calls as well as puts in the Black Scholes pricing
environment

C) Gamma will be at its highest ( i.e. when delta is the most sensitive ) for short term options that are at-
the-money. Gamma will be the same for both calls as well as puts in the Black Scholes pricing
environment

D) Gamma will be at its lowest ( i.e. when delta is the most sensitive ) for long term options that are at-
the-money. Gamma will be different for both calls as well as puts in the Black Scholes pricing environment

E) Gamma will be at its highest ( i.e. when delta is the most sensitive ) for short term options that are at-
the-money. Gamma will be different for both calls as well as puts in the Black Scholes pricing environment

F) Gamma will be at its highest ( i.e. when delta is the least sensitive ) for long term options that are at-
the-money. Gamma will be different for both calls as well as puts in the Black Scholes pricing environment

ANSWER

The following is considered to be correct:

Gamma will be at its highest ( i.e. when delta is the most sensitive ) for short term options that are at-
the-money. Gamma will be the same for both calls as well as puts in the Black Scholes pricing
environment

Thus, the correct answer is C.

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Sample From: Valuation and Risk Models

Level: FRM Part I

QUESTION

Consider your knowledge of duration.

From the following given options, determine which of the following is (are) most likely correct:

i) We consider effective duration to be an approximation. This, as the calculation does not take into
account the price-yield graph’s curvature.
ii) Interest rate risk and price volatility have a direct relationship
iii) Above the line, the formula with respect to effective duration will assume that rates go up and down
by the same basis point (bps) amounts

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii

ANSWER

The following are considered to be correct:

 We consider effective duration to be an approximation. This, as the calculation does not take into
account the price-yield graph’s curvature.
 Interest rate risk and price volatility have a direct relationship
 Above the line, the formula with respect to effective duration will assume that rates go up and down
by the same basis point (bps) amounts

Thus, the correct answer is G.

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Sample From: Valuation and Risk Models

Level: FRM Part I

QUESTION

Consider your knowledge of stress testing and determine which of the following are most likely correct
with respect to this financial tool:

i) Stress testing is considered to be very objective

ii) Stress testing is unable to compliment Value-at-Risk computations
iii) Having more scenarios presented will better aid in understanding a portfolio’s risk exposures

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered correct with respect to stress testing:

 Stress testing is considered to be very subjective

 Stress testing is able to compliment Value-at-Risk computations
 Having more scenarios presented will not aid in understanding a portfolio’s risk exposures (too
many scenarios will cause problems in interpretation)

Thus, the correct answer is H.

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Sample Questions & Answers

FRM Part II

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Sample From: Market Risk Measurement and Management

Level: FRM Part II

QUESTION

From your knowledge of Term Structure Models, select which of the following is not likely to incorporate
negative interest rates:

i) The Cox-Ingersoll-Ross ( CIR ) Model

ii) The Merton Model
iii) The Ho-Lee Model

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

 Under the Cox-Ingersoll-Ross ( CIR ) Model, we will not see negative interest rates

 The Vasicek Model and the Ho-Lee Model can theoretically give negative interest rates

Thus, the correct answer is A.

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Sample From: Market Risk Measurement and Management

Level: FRM Part II

QUESTION

As the Chief Risk Officer within your organization, you are asked to explain the meaning of what exactly is
a Copula. You correctly state that:

i) Copula is a statistical measure that represents a multivariate uniform distribution

ii) Copula will only examine the dependence between two variables each time

iii) As a singular function, Copula will be able to correlate several securities

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Copula is a statistical measure that represents a multivariate uniform distribution

 Copula will examine the dependence or association between multiple variables.

 As a singular function, Copula will be able to correlate several securities

Thus, the correct answer is E.

“ Copula “ is a statistical measure that represents a multivariate uniform distribution, which examines the
association or dependence between multiple variables. Although the statistical calculation of a copula was
invented in 1957, it was not applied to financial markets and finance until the late 1990s.

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Sample From: Market Risk Measurement and Management

Level: FRM Part II

QUESTION

Consider a scenario where trading frequently occurs in a particular commodity that is considered to be
‘seasonal’ in its nature. From the given selections, determine which statement/s is/are most likely to be
correct:

i) By employing an Equally Weighted Estimated Shortfall ( ES ) tactic, the given commodity’s seasonality
will not be adequately captured

ii) By employing an Equally Weighted Value at Risk ( VaR ) tactic, the given commodity’s seasonality will
not be adequately captured

iii) By employing an Equally Weighted Estimated Shortfall ( ES ) tactic, the given commodity’s seasonality
will be adequately captured

iv) By employing an Equally Weighted Value at Risk ( VaR ) tactic, the given commodity’s seasonality will
be adequately captured

A) i only
B) ii only
C) iii only
D) iv only
E) i and ii only
F) iii and iv only
G) i and iv only
H) ii and iii only
I) None of the above

ANSWER

Equal Weighting will present the same problem in both Estimated Shortfall and Value at Risk, as there will
be different risks associated with the different seasons. The following are considered to be correct:

 By employing an Equally Weighted Estimated Shortfall ( ES ) tactic, the given commodity’s

seasonality will not be adequately captured

 By employing an Equally Weighted Value at Risk ( VaR ) tactic, the given commodity’s seasonality
will not be adequately captured

Thus, the correct answer is E.

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Sample From: Market Risk Measurement and Management

Level: FRM Part II

QUESTION

From your knowledge of the various Simulation methodologies, select which of the following is/are
disadvantage/s of Historical Simulation:

i) The results of Historical Simulation may include ghosting effects

ii) The results of Historical Simulation may include shadow effects

iii) Historical Simulation is considered to be simplistic in its nature

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be disadvantages:

 The results of Historical Simulation may include ghosting effects

 The results of Historical Simulation may include shadow effects

Thus, the correct answer is D.

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Sample From: Market Risk Measurement and Management

Level: FRM Part II

QUESTION

Consider your knowledge of the international credit crisis, particularly as it relates to the ‘originate-to-
distribute’ model approach of many banks during that period, and determine which of the following
statement/s is/are correct.

i) By using the originate-to-distribute model, systematic risks could have been reduced as fewer risks
would be within the banks

ii) Mortgage originators were faced with warehouse risk and lost funds from this type of exposure. This
was due to the fact that loans had to be kept on the company balance sheets before securitization could
take place

iii) Many mortgage originators escaped going bankrupt during the financial crisis

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 By using the originate-to-distribute model, systematic risks could have been reduced as fewer risks
would be within the banks. This is a true statement, however, many banking institutions decided
to keep the risks during the period.

 Mortgage originators were faced with warehouse risk and lost funds from this type of exposure.
This was due to the fact that loans had to be kept on the company balance sheets before
securitization could take place.

 Many mortgage originators experienced going bankrupt during the crisis due to the large amount
of losses suffered over the period.

Thus, the correct answer is D.

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Sample From: Credit Risk Measurement and Management

Level: FRM Part II

QUESTION

Limitations of Quantitative Credit Analysis include:

i) Reliance on Historical Data

ii) Quality of Data
iii) Over-Modelling

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

Limitations of Quantitative Credit Analysis include:

 Reliance on Historical Data

 Quality of Data

 Over-Modelling

 Under-Modelling

 Difficulty of future credit predictions based on historical data

Thus, the correct answer is G.

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Sample From: Credit Risk Measurement and Management

Level: FRM Part II

QUESTION

Consider the following definition:

The Recovery Rate, calculated as ( 1 – Loss Rate ), is the extent to which principal and accrued interest on
defaulted debt can be recovered, expressed as a percentage of face value. The Recovery Rate can also be
defined as the value of a security when it emerges from default. It is also noted that the Loss Rate is
generally swayed by the volatility of the underlying assets or securities.

In consideration of the aforementioned, determine which of the following would most likely carry the
highest Recovery Rate.

A) A hedge fund that is highly leveraged

B) A hedge fund that is lowly leveraged
C) A company operating in a volatile emerging market
D) A specialized tech company in the Americas
E) A high-demand asset manufacturing company
F) A specialized tech company in the emerging market
G) None of the above

ANSWER

The highest Recovery Rate will be held by that institution whose assets are considered to be:

 Tangible and
 May be easily resold in the event of a default

Thus, the best answer is E.

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Sample From: Credit Risk Measurement and Management

Level: FRM Part II

QUESTION

Consider your knowledge of the Merton Model as developed by Robert C. Merton and determine which
of the following is/are most likely correct:

Employing the use of the Merton Model, if all other parameters are constant, the value of credit-sensitive
debt will decrease as:

i) The firm’s valuation increases

ii) The firm’s volatility increases

iii) The maturity increases

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

Employing the use of the Merton Model, if all other parameters are constant, the value of credit-sensitive
debt will decrease as:

 The firm’s valuation increases

 The firm’s volatility increases

 The maturity increases

Thus, the correct answer is G.

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Sample From: Credit Risk Measurement and Management

Level: FRM Part II

QUESTION

The financial practice of pooling various types of contractual debt such as residential mortgages,
commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which
generate receivables) and selling their related cash flows to third party investors as securities, which may
be described as bonds, pass-through securities, or collateralized debt obligations (CDOs)

This is most likely the definition of:

A) Collateralization
B) Securitization
C) Syndication
D) Debt Assignment
E) Debt Mortality
F) None of the above

ANSWER

Securitization is the financial practice of pooling various types of contractual debt such as residential
mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets
which generate receivables) and selling their related cash flows to third party investors as securities,
which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs)

Thus, the correct answer is B.

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Sample From: Credit Risk Measurement and Management

Level: FRM Part II

QUESTION

Consider your knowledge of Credit Risk and the various models that have been developed over the years
to assess such risk, and then determine which of the following is/are most likely correct:

i) The KMV model is based on the structural approach to calculate EDF. It is best when applied to publicly
traded companies. This model also assumes that the company is made up of debt and equity.

ii) In the CreditRisk+ Model each obligor has only two possible end-of-period states, default and non-
default. In the event of default, the lender suffers a loss of fixed size; this is the lender’s exposure to the
obligor.

iii) The CreditMetrics approach not only captures defaults, but migrations across non-default grades as
well. Given a set of forward credit spreads for each grade, CreditMetrics can estimate a distribution over
the change in mark-to-market value attributable to portfolio credit risk.

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

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ANSWER

The following are considered to be correct:

 The KMV model is based on the structural approach to calculate EDF (credit risk is driven by the
firm value process). It is best when applied to publicly traded companies, where the value of
equity is determined by the stock market. In the KMV Model, having a complex financial structure
is welcomed. This model also assumes that the company is made up of debt and equity.

 The CreditRisk+ Model was originally been developed by Credit Suisse Financial Products (CSFP)
and is a model of default risk. Each obligor has only two possible end-of-period states, default and
non-default. In the event of default, the lender suffers a loss of fixed size; this is the lender’s
exposure to the obligor.

 CreditMetrics captures not only defaults, but migrations across non-default grades as well. Given a
set of forward credit spreads for each grade, CreditMetrics can estimate a distribution over the
change in mark-to-market value attributable to portfolio credit risk.

Thus, the correct answer is G.

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Sample From: Operational Risk and Resiliency

Level: FRM Part II

QUESTION

Determine which of the following is/are correct with respect to Loss Severity Distributions.

Loss Severity Distributions:

i) Are bounded by +1

ii) Are Asymmetrical, having long tails to the left

iii) Should include large losses

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

Loss Severity Distributions:

 Are bounded by zero ( 0 )

 Are Asymmetrical, having long tails to the right

 Should include large losses

Thus, the correct answer is C.

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Sample From: Operational Risk and Resiliency

Level: FRM Part II

QUESTION

Determine which of the following is/are considered to be true:

i) Market Risk Models typically depend on Historical Data

ii) Operational Risk VaR Models typically depend on Scenario Analysis

iii) Backtesting is considered to be a useful form of validation for Market Risk Models

iv) Market Risk Models and Operational Risk Models differ with respect to the time horizon used in
calculating Value at Risk

A) i and ii only
B) i and iii only
C) i, ii and iii only
D) i, ii and iv only
E) i, iii and iv only
F) ii, iii and iv only
G) i, ii, iii and iv
H) None of the above

ANSWER

The following are considered to be true:

 Market Risk Models typically depend on Historical Data

 Operational Risk VaR Models typically depend on Scenario Analysis

 Backtesting is considered to be a useful form of validation for Market Risk Models

 Market Risk Models and Operational Risk Models differ with respect to the time horizon used in
calculating Value at Risk

Thus, the correct answer is G.

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Sample From: Operational Risk and Resiliency

Level: FRM Part II

QUESTION

With regards to the Basel II Non‐Advanced Methodology, determine which of the following is most likely
correct:

A) The Standardized Approach will incorporate information from the last 1 year of Gross Income to derive
a bank’s Operational Risk Capital charge

B) The Standardized Approach will incorporate information from the last 2 years of Gross Income to
derive a bank’s Operational Risk Capital charge

C) The Standardized Approach will incorporate information from the last 3 years of Gross Income to
derive a bank’s Operational Risk Capital charge

D) The Standardized Approach will incorporate information from the last 4 years of Gross Income to
derive a bank’s Operational Risk Capital charge

E) The Standardized Approach will incorporate information from the last 5 years of Gross Income to derive
a bank’s Operational Risk Capital charge

F) The Standardized Approach will incorporate information from the last 6 years of Gross Income to derive
a bank’s Operational Risk Capital charge

G) None of the above

ANSWER

The following is considered to be correct:

The Standardized Approach will incorporate information from the last 3 years of Gross Income to derive a
bank’s Operational Risk Capital charge

Thus, the correct answer is C.

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Sample From: Operational Risk and Resiliency

Level: FRM Part II

QUESTION

Determine which of the following is/are most likely correct:

i) Eurodollar Rates are the consideration for Uncollateralized Deposits

ii) The Fed Funds Rate is the consideration for Collateralized Loans

iii) Having an increase in the TED Spread will cause the cost of bank borrowing to go down

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Eurodollar Rates are the consideration for Uncollateralized Deposits

 The Fed Funds Rate is the consideration for Collateralized Loans

 Having an increase in the TED Spread will cause the cost of bank borrowing to go up

Thus, the correct answer is D.

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Sample From: Operational Risk and Resiliency

Level: FRM Part II

QUESTION

Determine the correct risk definition pairings below:

i) Rollover Risk is a measure of the difference between the interest income generated by financial
institutions and the amount of interest paid out to their lenders, relative to the amount of their interest-
earning assets

ii) Matched Funding refers to the matching of assets and liabilities with the same duration

iii) Interest Margin Risk is a risk associated with the refinancing of debt. This is commonly faced by
countries and companies when their debt is about to mature and needs to be rolled over into new debt

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Net Interest Margin ( NIM ) is a measure of the difference between the interest income generated
by financial institutions and the amount of interest paid out to their lenders, relative to the
amount of their interest-earning assets

 Matched Funding refers to the matching of assets and liabilities with the same duration

 Rollover Risk is a risk associated with the refinancing of debt. Rollover Risk is commonly faced by
countries and companies when their debt is about to mature and needs to be rolled over into new
debt

Thus, the correct answer is B.

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Sample From: Risk Management and Investment Management

Level: FRM Part II

QUESTION

Assumptions of the Capital Assets Pricing Model ( CAPM ) will include which of the following:

i) There are no taxes

ii) There are no transaction costs

iii) Investors have homogenous expectations with respect to expected returns

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

Assumptions of the Capital Assets Pricing Model ( CAPM ) will include:

 There are no taxes

 There are no transaction costs

 Investors have homogenous expectations with respect to expected returns

 Investors can borrow and lend at the risk free rate

 Investors can short sell any stock

Thus, the correct answer is G.

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Sample From: Risk Management and Investment Management

Level: FRM Part II

QUESTION

You are being asked to consider a hedge fund that is long US$459 million in a given set of equities and
short US$258 in another set of stocks. Assuming that the risk free rate of interest is 1.09%, the fund’s
equity is US$222 and the fund’s beta is approximately 0.59, determine this entity’s Gross Leverage and
Net Leverage.

A) Gross Leverage = 3.23 Net Leverage = 0.91

B) Gross Leverage = 4.25 Net Leverage = 1.23
C) Gross Leverage = 2.89 Net Leverage = 0.87
D) Gross Leverage = 1.69 Net Leverage = 0.25
E) Gross Leverage = 3.87 Net Leverage = 0.68
F) Gross Leverage = 4.59 Net Leverage = 0.88
G) None of the above

ANSWER

Ignoring the useless data, we have the following;

The Gross Leverage will be given: ( 459 + 258 ) / 222 = 3.23

The Net Leverage will be given: ( 459 - 258 ) / 222 = 0.91

Thus, the correct answer is A.

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Sample From: Risk Management and Investment Management

Level: FRM Part II

QUESTION

Determine which of the following is/are most likely correct:

i) Gamma measures the rate at which delta changes when the underlying stock moves $1

ii) Gamma is lowest for short-term, at-the-money options

iii) Gamma can only be positive

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Gamma measures the rate at which delta changes when the underlying stock moves $1

 Gamma is highest for short-term, at-the-money options

 Gamma can be either positive or negative

Thus, the correct answer is A.

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Sample From: Risk Management and Investment Management

Level: FRM Part II

QUESTION

You are being asked to consider your knowledge of Portfolio Construction Techniques in Risk
Management.

Determine which of the following is/are most likely correct:

i) Quadratic Programming will explicitly consider only two elements: Alpha and Transaction Costs

ii) An advantage of Quadratic Programming is that it can include all the constraints and limitations one
finds in a linear program. This should be the best of all worlds

iii) A disadvantage of Quadratic Programming is that it requires a great many more inputs than the other
portfolio construction techniques

A) i only
B) ii only
C) iii only
D) i and ii only
E) i and iii only
F) ii and iii only
G) i, ii and iii
H) None of the above

ANSWER

The following are considered to be correct:

 Quadratic Programming will explicitly consider three ( 3 ) elements: Alpha, Risk and Transaction
Costs

 An advantage of Quadratic Programming is that it can include all the constraints and limitations
one finds in a linear program. This should be the best of all worlds

 A disadvantage of Quadratic Programming is that it requires a great many more inputs than the
other portfolio construction techniques

Thus, the correct answer is F.

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Sample From: Risk Management and Investment Management

Level: FRM Part II

QUESTION

You are told that the investment manager of a large fund has experienced returns coming in below the
benchmark S&P 500 index only a few times over the past 10 years.

What is the best risk measure that you could employ to determine the manager’s performance?

A) The Sharpe Ratio

B) The Jensen Alpha
C) The Information Ratio
D) The Sortino Ratio
E) The Systematic Risk
F) The Unsystematic Risk

ANSWER

In this example, we are essentially trying to determine the downside performance of the fund manager
and the Sortino Ratio would be the best option as it measures the downside risk of returns. Given the
relatively good performance over the years, using several of the other measures will produce results that
are unfairly high and in favour with the manager.

Thus, the correct answer is D.

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