Financial Risk Manager (FRM) – Part II Verified
Questions, Correct Answers, and Detailed Explanations
for Computer Science Students||Already Graded A+
1. Which of the following best describes wrong-way risk (WWR)?
A. Risk that exposure decreases when counterparty credit quality
deteriorates
B. Risk that exposure is independent of counterparty credit quality
C. Risk that exposure increases when counterparty credit quality
deteriorates
D. Risk that exposure decreases when counterparty credit quality
improves
Answer: C
WRR occurs when counterparty risk increases simultaneously with
exposure, amplifying losses.
2. Which method is most commonly used to backtest Value-at-Risk
(VaR)?
A. Stress testing
B. Kupiec POF test
C. Scenario analysis
D. Expected shortfall comparison
Answer: B
The Kupiec Proportion of Failures test compares the observed number
of VaR breaches with the expected number.
3. Economic capital is best defined as:
A. Regulatory minimum capital
B. Capital required for daily operational needs
,C. Capital needed to absorb unexpected losses
D. Capital set aside for expected losses
Answer: C
Economic capital covers unexpected—not expected—losses.
4. Liquidity risk is primarily concerned with:
A. Market price movements
B. Ability to fund obligations when due
C. Credit quality deterioration
D. Settlement system failures
Answer: B
Liquidity risk relates to meeting cash and funding needs on time.
5. The principal purpose of stress testing is to:
A. Improve daily P&L
B. Estimate average portfolio returns
C. Evaluate portfolio resilience under extreme scenarios
D. Measure daily exposure volatility
Answer: C
Stress tests focus on tail events to assess robustness.
6. Expected shortfall differs from VaR because ES:
A. Ignores tail losses
B. Measures the average loss beyond VaR
C. Is always lower than VaR
D. Cannot be backtested
Answer: B
ES captures tail severity, not just the loss threshold.
,7. In counterparty credit risk, Potential Future Exposure (PFE)
represents:
A. Worst-case exposure with probability 100%
B. Exposure projected with some confidence level
C. Average expected exposure
D. Current exposure only
Answer: B
PFE is a quantile of future exposure distribution.
8. Which of the following risks is not part of operational risk?
A. Legal risk
B. Model risk
C. External events
D. Interest rate changes
Answer: D
Market risks like interest rate changes are outside operational risk.
9. A key assumption of Merton’s structural credit model is:
A. Firm asset value is unobservable
B. Default occurs when asset value drops below debt obligations
C. Default probability is constant over time
D. Firm liabilities are stochastic
Answer: B
Merton models default as an asset-value trigger.
10. What is the primary purpose of credit valuation adjustment
(CVA)?
, A. To account for funding costs
B. To measure counterparty risk in derivatives
C. To adjust regulatory capital
D. To hedge market exposure
Answer: B
CVA represents the market value of counterparty credit risk.
11. Which risk measure is coherent under industry standards?
A. Variance
B. Standard deviation
C. VaR (not always)
D. Expected shortfall
Answer: D
Expected shortfall satisfies the four coherence axioms.
12. Basel III introduced the Liquidity Coverage Ratio (LCR) to
ensure:
A. Long-term asset-liability matching
B. Adequate buffer for 30-day stress scenarios
C. Profitability under normal conditions
D. Hedging of uncollateralized exposure
Answer: B
LCR requires sufficient high-quality liquid assets for 30-day stress.
13. Operational risk capital under the SMA is based on:
A. Internal models
B. Business indicator and loss multiplier
Questions, Correct Answers, and Detailed Explanations
for Computer Science Students||Already Graded A+
1. Which of the following best describes wrong-way risk (WWR)?
A. Risk that exposure decreases when counterparty credit quality
deteriorates
B. Risk that exposure is independent of counterparty credit quality
C. Risk that exposure increases when counterparty credit quality
deteriorates
D. Risk that exposure decreases when counterparty credit quality
improves
Answer: C
WRR occurs when counterparty risk increases simultaneously with
exposure, amplifying losses.
2. Which method is most commonly used to backtest Value-at-Risk
(VaR)?
A. Stress testing
B. Kupiec POF test
C. Scenario analysis
D. Expected shortfall comparison
Answer: B
The Kupiec Proportion of Failures test compares the observed number
of VaR breaches with the expected number.
3. Economic capital is best defined as:
A. Regulatory minimum capital
B. Capital required for daily operational needs
,C. Capital needed to absorb unexpected losses
D. Capital set aside for expected losses
Answer: C
Economic capital covers unexpected—not expected—losses.
4. Liquidity risk is primarily concerned with:
A. Market price movements
B. Ability to fund obligations when due
C. Credit quality deterioration
D. Settlement system failures
Answer: B
Liquidity risk relates to meeting cash and funding needs on time.
5. The principal purpose of stress testing is to:
A. Improve daily P&L
B. Estimate average portfolio returns
C. Evaluate portfolio resilience under extreme scenarios
D. Measure daily exposure volatility
Answer: C
Stress tests focus on tail events to assess robustness.
6. Expected shortfall differs from VaR because ES:
A. Ignores tail losses
B. Measures the average loss beyond VaR
C. Is always lower than VaR
D. Cannot be backtested
Answer: B
ES captures tail severity, not just the loss threshold.
,7. In counterparty credit risk, Potential Future Exposure (PFE)
represents:
A. Worst-case exposure with probability 100%
B. Exposure projected with some confidence level
C. Average expected exposure
D. Current exposure only
Answer: B
PFE is a quantile of future exposure distribution.
8. Which of the following risks is not part of operational risk?
A. Legal risk
B. Model risk
C. External events
D. Interest rate changes
Answer: D
Market risks like interest rate changes are outside operational risk.
9. A key assumption of Merton’s structural credit model is:
A. Firm asset value is unobservable
B. Default occurs when asset value drops below debt obligations
C. Default probability is constant over time
D. Firm liabilities are stochastic
Answer: B
Merton models default as an asset-value trigger.
10. What is the primary purpose of credit valuation adjustment
(CVA)?
, A. To account for funding costs
B. To measure counterparty risk in derivatives
C. To adjust regulatory capital
D. To hedge market exposure
Answer: B
CVA represents the market value of counterparty credit risk.
11. Which risk measure is coherent under industry standards?
A. Variance
B. Standard deviation
C. VaR (not always)
D. Expected shortfall
Answer: D
Expected shortfall satisfies the four coherence axioms.
12. Basel III introduced the Liquidity Coverage Ratio (LCR) to
ensure:
A. Long-term asset-liability matching
B. Adequate buffer for 30-day stress scenarios
C. Profitability under normal conditions
D. Hedging of uncollateralized exposure
Answer: B
LCR requires sufficient high-quality liquid assets for 30-day stress.
13. Operational risk capital under the SMA is based on:
A. Internal models
B. Business indicator and loss multiplier
