Financial Risk Manager (FRM)
Examination Practice Exam 2026 | 100
Questions & Answers with Detailed
Rationales | Complete FRM Exam Prep
& Study Guide
1. Which type of risk refers to the possibility of loss resulting from changes in
market prices such as interest rates, foreign exchange rates, and equity
prices?
A. Operational risk
B. Market risk
C. Liquidity risk
D. Legal risk
Answer: Market risk
Rationale: Market risk arises from adverse movements in financial market
variables, including interest rates, exchange rates, equity prices, and commodity
prices.
2. What is the primary purpose of risk management in a financial institution?
A. Maximize accounting profits regardless of risk
B. Eliminate every possible source of uncertainty
,C. Identify, measure, monitor, and manage risks within acceptable limits
D. Avoid all financial market activity
Answer: Identify, measure, monitor, and manage risks within acceptable limits
Rationale: Effective risk management does not eliminate risk; it helps
institutions understand exposures and keep them within defined risk tolerances.
3. Value at Risk (VaR) is primarily designed to estimate:
A. Expected annual revenue
B. Potential loss over a specified horizon at a given confidence level
C. Maximum possible loss under all circumstances
D. Expected return on equity
Answer: Potential loss over a specified horizon at a given confidence level
Rationale: VaR estimates a loss threshold that should not be exceeded over a
specified time horizon at a selected confidence level, under the model's
assumptions.
4. A one-day 99% VaR of $5 million means:
A. The institution will lose exactly $5 million every day
B. The institution cannot lose more than $5 million
C. Under the model assumptions, there is approximately a 1% chance of losing
more than $5 million in one day
D. The expected daily loss is $5 million
Answer: Under the model assumptions, there is approximately a 1% chance of
losing more than $5 million in one day
Rationale: At a 99% confidence level, VaR represents a loss threshold exceeded
approximately 1% of the time under the relevant assumptions.
5. Which VaR approach uses historical changes in market variables to
generate potential portfolio outcomes?
,A. Monte Carlo simulation
B. Variance-covariance method
C. Historical simulation
D. Fundamental analysis
Answer: Historical simulation
Rationale: Historical simulation applies actual historical market movements to
the current portfolio to construct a distribution of potential profits and losses.
6. Which VaR methodology assumes that risk-factor returns follow a specified
probability distribution, commonly a normal distribution?
A. Historical simulation
B. Parametric VaR
C. Stress testing
D. Scenario analysis
Answer: Parametric VaR
Rationale: Parametric VaR uses statistical assumptions about return
distributions and relationships among risk factors to calculate portfolio risk.
7. What is a major weakness of standard VaR?
A. It cannot be calculated numerically
B. It does not describe the magnitude of losses beyond the VaR threshold
C. It always assumes zero volatility
D. It measures only credit risk
Answer: It does not describe the magnitude of losses beyond the VaR threshold
Rationale: VaR identifies a percentile loss threshold but does not indicate how
severe losses may become once that threshold is exceeded.
8. Expected Shortfall (ES) measures:
, A. The median portfolio return
B. The maximum historical return
C. The average loss conditional on losses exceeding a specified VaR threshold
D. The probability of default
Answer: The average loss conditional on losses exceeding a specified VaR
threshold
Rationale: Expected Shortfall focuses on the tail of the loss distribution and
estimates the average loss beyond a selected VaR percentile.
9. Which measure is most directly associated with the sensitivity of a bond's
price to changes in interest rates?
A. Beta
B. Duration
C. Recovery rate
D. Probability of default
Answer: Duration
Rationale: Duration measures the approximate percentage change in a bond's
price for a given change in yield, with modified duration commonly used for
price sensitivity.
10.If interest rates rise, the price of a conventional fixed-rate bond generally:
A. Rises
B. Remains unchanged
C. Falls
D. Becomes zero
Answer: Falls
Rationale: Bond prices and yields generally move inversely because existing
fixed coupon payments become less attractive as market yields increase.
11.Convexity is useful in fixed-income risk management because it:
Examination Practice Exam 2026 | 100
Questions & Answers with Detailed
Rationales | Complete FRM Exam Prep
& Study Guide
1. Which type of risk refers to the possibility of loss resulting from changes in
market prices such as interest rates, foreign exchange rates, and equity
prices?
A. Operational risk
B. Market risk
C. Liquidity risk
D. Legal risk
Answer: Market risk
Rationale: Market risk arises from adverse movements in financial market
variables, including interest rates, exchange rates, equity prices, and commodity
prices.
2. What is the primary purpose of risk management in a financial institution?
A. Maximize accounting profits regardless of risk
B. Eliminate every possible source of uncertainty
,C. Identify, measure, monitor, and manage risks within acceptable limits
D. Avoid all financial market activity
Answer: Identify, measure, monitor, and manage risks within acceptable limits
Rationale: Effective risk management does not eliminate risk; it helps
institutions understand exposures and keep them within defined risk tolerances.
3. Value at Risk (VaR) is primarily designed to estimate:
A. Expected annual revenue
B. Potential loss over a specified horizon at a given confidence level
C. Maximum possible loss under all circumstances
D. Expected return on equity
Answer: Potential loss over a specified horizon at a given confidence level
Rationale: VaR estimates a loss threshold that should not be exceeded over a
specified time horizon at a selected confidence level, under the model's
assumptions.
4. A one-day 99% VaR of $5 million means:
A. The institution will lose exactly $5 million every day
B. The institution cannot lose more than $5 million
C. Under the model assumptions, there is approximately a 1% chance of losing
more than $5 million in one day
D. The expected daily loss is $5 million
Answer: Under the model assumptions, there is approximately a 1% chance of
losing more than $5 million in one day
Rationale: At a 99% confidence level, VaR represents a loss threshold exceeded
approximately 1% of the time under the relevant assumptions.
5. Which VaR approach uses historical changes in market variables to
generate potential portfolio outcomes?
,A. Monte Carlo simulation
B. Variance-covariance method
C. Historical simulation
D. Fundamental analysis
Answer: Historical simulation
Rationale: Historical simulation applies actual historical market movements to
the current portfolio to construct a distribution of potential profits and losses.
6. Which VaR methodology assumes that risk-factor returns follow a specified
probability distribution, commonly a normal distribution?
A. Historical simulation
B. Parametric VaR
C. Stress testing
D. Scenario analysis
Answer: Parametric VaR
Rationale: Parametric VaR uses statistical assumptions about return
distributions and relationships among risk factors to calculate portfolio risk.
7. What is a major weakness of standard VaR?
A. It cannot be calculated numerically
B. It does not describe the magnitude of losses beyond the VaR threshold
C. It always assumes zero volatility
D. It measures only credit risk
Answer: It does not describe the magnitude of losses beyond the VaR threshold
Rationale: VaR identifies a percentile loss threshold but does not indicate how
severe losses may become once that threshold is exceeded.
8. Expected Shortfall (ES) measures:
, A. The median portfolio return
B. The maximum historical return
C. The average loss conditional on losses exceeding a specified VaR threshold
D. The probability of default
Answer: The average loss conditional on losses exceeding a specified VaR
threshold
Rationale: Expected Shortfall focuses on the tail of the loss distribution and
estimates the average loss beyond a selected VaR percentile.
9. Which measure is most directly associated with the sensitivity of a bond's
price to changes in interest rates?
A. Beta
B. Duration
C. Recovery rate
D. Probability of default
Answer: Duration
Rationale: Duration measures the approximate percentage change in a bond's
price for a given change in yield, with modified duration commonly used for
price sensitivity.
10.If interest rates rise, the price of a conventional fixed-rate bond generally:
A. Rises
B. Remains unchanged
C. Falls
D. Becomes zero
Answer: Falls
Rationale: Bond prices and yields generally move inversely because existing
fixed coupon payments become less attractive as market yields increase.
11.Convexity is useful in fixed-income risk management because it:
