FRM Part 1 Practice Questions — All Questions

The risk that a counterparty fails to meet its financial obligations is:

• a.Liquidity risk
• b.Market risk
• c.Credit risk✓
• d.Model risk

Credit (default) risk is the risk a counterparty does not pay as agreed.

The risk of loss from movements in prices, rates, or volatility is:

• a.Reputation risk
• b.Legal risk
• c.Market risk✓
• d.Operational risk

Market risk stems from changes in market prices and rates.

Good risk management aims to:

• a.Ignore tail events
• b.Eliminate all risk
• c.Maximize risk for higher returns
• d.Take risks deliberately and be compensated for them✓

Risk management is about taking appropriate, well-understood, compensated risks.

The risk that an asset cannot be sold quickly without a large price concession is:

• a.Operational risk
• b.Credit risk
• c.Liquidity risk✓
• d.Market risk

Liquidity risk is the difficulty of transacting without moving the price.

A correlation coefficient can range between:

• a.0 and 1
• b.-1 and +1✓
• c.0 and infinity
• d.-100 and +100

Correlation is bounded between -1 and +1.

The normal distribution is:

• a.Bimodal by definition
• b.Always skewed right
• c.Symmetric and bell-shaped✓
• d.Uniform

The normal distribution is symmetric and bell-shaped around its mean.

Diversification across imperfectly correlated assets primarily reduces:

• a.Correlation to +1
• b.Return
• c.Portfolio variance✓
• d.The risk-free rate

Combining imperfectly correlated assets lowers overall portfolio variance.

Variance is:

• a.The square of the standard deviation✓
• b.Always negative
• c.The square root of the mean
• d.The same as correlation

Variance equals the standard deviation squared.

A call option gives the holder the right to:

• a.Sell the underlying at the strike
• b.Default without penalty
• c.Receive fixed coupons
• d.Buy the underlying at the strike✓

A call is the right (not obligation) to buy the underlying at the strike price.

A key difference between futures and forwards is that futures are:

• a.Options, not obligations
• b.Exchange-traded and marked to market daily✓
• c.Always customized and unregulated
• d.Never settled

Futures are standardized, exchange-traded, and marked to market daily; forwards are OTC.

An interest-rate swap typically exchanges:

• a.Two stocks
• b.Fixed for floating interest payments✓
• c.Two currencies' principal only
• d.Commodities for bonds

A plain-vanilla interest-rate swap exchanges fixed-rate for floating-rate payments.

Using derivatives to reduce an existing exposure is called:

• a.Arbitraging
• b.Speculating
• c.Leveraging
• d.Hedging✓

Hedging uses derivatives to offset an existing risk exposure.

Value at Risk (VaR) estimates:

• a.The guaranteed maximum loss ever
• b.The default probability
• c.The maximum expected loss over a horizon at a given confidence level✓
• d.The average annual return

VaR is the loss threshold not expected to be exceeded at a stated confidence over a horizon.

A key limitation of VaR is that it:

• a.Cannot be computed
• b.Says little about the size of losses beyond the threshold✓
• c.Only applies to stocks
• d.Guarantees no larger loss

VaR does not describe the magnitude of losses in the tail beyond the threshold.

Stress testing complements VaR by:

• a.Examining extreme but plausible scenarios✓
• b.Lowering capital requirements
• c.Ignoring tail events
• d.Replacing all models

Stress tests probe extreme scenarios that normal VaR may understate.

Expected shortfall (conditional VaR) measures:

• a.The best-case gain
• b.The average loss given that losses exceed the VaR threshold✓
• c.The risk-free rate
• d.The median return

Expected shortfall averages losses in the tail beyond VaR.

Loss given default (LGD) represents:

• a.The maturity
• b.The portion of exposure lost if default occurs✓
• c.The coupon rate
• d.The chance of default

LGD is the fraction of exposure not recovered when a counterparty defaults.

Expected credit loss is commonly modeled as a function of:

• a.Only the maturity
• b.The stock price alone
• c.Probability of default, loss given default, and exposure at default✓
• d.Only the coupon

Expected loss ≈ PD × LGD × EAD.

A rogue-trading loss from a control failure is an example of:

• a.Operational risk✓
• b.Market risk
• c.Liquidity risk
• d.Credit risk

Operational risk arises from failed processes, people, or systems.