Financial Risk Manager (Frm)
Examination Questions And Correct
Answers (Verified Answers) Plus
Rationales 2026 Q&A | Instant
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Question 1
Which of the following best describes market risk?
A. Risk of loss due to borrower default
B. Risk arising from changes in market prices
C. Risk caused by operational failures
D. Risk from inadequate liquidity management
Correct answer: B
Rationale: Market risk refers to the potential for financial loss due to
movements in market variables such as interest rates, equity prices, exchange
rates, and commodity prices. It is distinct from credit, operational, and liquidity
risks, which arise from different sources within financial systems.
Question 2
Value at Risk (VaR) primarily estimates:
A. Maximum expected profit
B. Expected average return
C. Potential loss over a time horizon at a given confidence level
D. Probability of default
Correct answer: C
Rationale: VaR quantifies the worst expected loss over a specified time period
,under normal market conditions at a given confidence level, such as 95% or 99%.
It does not estimate profit or default probability.
Question 3
Which distribution is most commonly associated with lognormal asset prices?
A. Normal distribution
B. Exponential distribution
C. Lognormal distribution
D. Binomial distribution
Correct answer: C
Rationale: Asset prices are typically modeled as lognormal because returns are
assumed to be normally distributed while prices themselves cannot be negative,
making the lognormal distribution appropriate.
Question 4
Credit risk is best defined as:
A. Risk of loss due to interest rate fluctuations
B. Risk of counterparty default
C. Risk of system failure
D. Risk of asset illiquidity
Correct answer: B
Rationale: Credit risk arises when a borrower or counterparty fails to meet
contractual obligations, leading to financial loss for the lender or investor.
Question 5
Which model is commonly used to estimate credit default probability?
A. Black-Scholes model
B. Merton structural model
C. CAPM model
,D. GARCH model
Correct answer: B
Rationale: The Merton model treats a firm's equity as a call option on its assets
and is widely used to derive default probabilities based on asset value dynamics.
Question 6
Operational risk includes:
A. Market price movements
B. Loan defaults
C. Internal fraud or system failures
D. Interest rate volatility
Correct answer: C
Rationale: Operational risk arises from failed internal processes, people,
systems, or external events, including fraud, system breakdowns, or human
error.
Question 7
Which of the following increases diversification benefits?
A. Perfect positive correlation
B. High positive correlation
C. Low or negative correlation
D. No correlation to returns
Correct answer: C
Rationale: Diversification is most effective when asset returns are uncorrelated
or negatively correlated, reducing portfolio variance.
Question 8
Standard deviation measures:
A. Expected return
, B. Systematic risk
C. Total volatility
D. Default probability
Correct answer: C
Rationale: Standard deviation measures the dispersion of returns around the
mean, representing total volatility of an asset or portfolio.
Question 9
Which of the following best describes liquidity risk?
A. Risk of market crash
B. Risk of inability to meet obligations due to cash shortage
C. Risk of interest rate changes
D. Risk of inflation
Correct answer: B
Rationale: Liquidity risk is the risk that an entity cannot meet short-term
obligations due to inability to convert assets into cash quickly without significant
loss.
Question 10
Expected Shortfall (ES) differs from VaR because it:
A. Ignores tail losses
B. Measures average loss beyond VaR
C. Measures profit distribution
D. Uses historical averages only
Correct answer: B
Rationale: Expected Shortfall considers the average of losses that occur beyond
the VaR threshold, making it more sensitive to tail risk.
Question 11
Examination Questions And Correct
Answers (Verified Answers) Plus
Rationales 2026 Q&A | Instant
Download Pdf
Question 1
Which of the following best describes market risk?
A. Risk of loss due to borrower default
B. Risk arising from changes in market prices
C. Risk caused by operational failures
D. Risk from inadequate liquidity management
Correct answer: B
Rationale: Market risk refers to the potential for financial loss due to
movements in market variables such as interest rates, equity prices, exchange
rates, and commodity prices. It is distinct from credit, operational, and liquidity
risks, which arise from different sources within financial systems.
Question 2
Value at Risk (VaR) primarily estimates:
A. Maximum expected profit
B. Expected average return
C. Potential loss over a time horizon at a given confidence level
D. Probability of default
Correct answer: C
Rationale: VaR quantifies the worst expected loss over a specified time period
,under normal market conditions at a given confidence level, such as 95% or 99%.
It does not estimate profit or default probability.
Question 3
Which distribution is most commonly associated with lognormal asset prices?
A. Normal distribution
B. Exponential distribution
C. Lognormal distribution
D. Binomial distribution
Correct answer: C
Rationale: Asset prices are typically modeled as lognormal because returns are
assumed to be normally distributed while prices themselves cannot be negative,
making the lognormal distribution appropriate.
Question 4
Credit risk is best defined as:
A. Risk of loss due to interest rate fluctuations
B. Risk of counterparty default
C. Risk of system failure
D. Risk of asset illiquidity
Correct answer: B
Rationale: Credit risk arises when a borrower or counterparty fails to meet
contractual obligations, leading to financial loss for the lender or investor.
Question 5
Which model is commonly used to estimate credit default probability?
A. Black-Scholes model
B. Merton structural model
C. CAPM model
,D. GARCH model
Correct answer: B
Rationale: The Merton model treats a firm's equity as a call option on its assets
and is widely used to derive default probabilities based on asset value dynamics.
Question 6
Operational risk includes:
A. Market price movements
B. Loan defaults
C. Internal fraud or system failures
D. Interest rate volatility
Correct answer: C
Rationale: Operational risk arises from failed internal processes, people,
systems, or external events, including fraud, system breakdowns, or human
error.
Question 7
Which of the following increases diversification benefits?
A. Perfect positive correlation
B. High positive correlation
C. Low or negative correlation
D. No correlation to returns
Correct answer: C
Rationale: Diversification is most effective when asset returns are uncorrelated
or negatively correlated, reducing portfolio variance.
Question 8
Standard deviation measures:
A. Expected return
, B. Systematic risk
C. Total volatility
D. Default probability
Correct answer: C
Rationale: Standard deviation measures the dispersion of returns around the
mean, representing total volatility of an asset or portfolio.
Question 9
Which of the following best describes liquidity risk?
A. Risk of market crash
B. Risk of inability to meet obligations due to cash shortage
C. Risk of interest rate changes
D. Risk of inflation
Correct answer: B
Rationale: Liquidity risk is the risk that an entity cannot meet short-term
obligations due to inability to convert assets into cash quickly without significant
loss.
Question 10
Expected Shortfall (ES) differs from VaR because it:
A. Ignores tail losses
B. Measures average loss beyond VaR
C. Measures profit distribution
D. Uses historical averages only
Correct answer: B
Rationale: Expected Shortfall considers the average of losses that occur beyond
the VaR threshold, making it more sensitive to tail risk.
Question 11
