Financial Risk Manager (FRM) Practice
Exam Questions And Correct Answers
(Verified Answers) Plus Rationales 2026
Q&A | Instant Download Pdf
Covers: Foundations of Risk Management, Quantitative Analysis, Financial
Markets & Products, Valuation & Risk Models
1. Which of the following best describes operational risk?
A. Risk of loss from changes in market prices
B. Risk of loss from failed internal processes, people, or systems
C. Risk of default by a counterparty
D. Risk due to liquidity constraints
Rationale: Operational risk arises from failures in internal processes, people,
systems, or external events, distinct from market or credit risk.
2. The primary goal of risk management is to:
A. Eliminate all risks
,B. Optimize risk–return trade-offs
C. Avoid losses entirely
D. Maximize returns
Rationale: Risk management aims to balance risk and return, not eliminate
risk, ensuring the firm takes risks that align with its risk appetite.
3. A bank calculates the expected loss of a loan as 2%. If the exposure is
$10 million, what is the expected loss amount?
A. $100,000
B. $150,000
C. $200,000
D. $250,000
Rationale: Expected loss = Exposure × Expected loss rate = $10,000,000 ×
0.02 = $200,000.
4. Which of the following best defines Value-at-Risk (VaR)?
A. The average loss over a period
B. The maximum potential loss over a specific horizon at a given
confidence level
C. The standard deviation of returns
D. The maximum gain possible
Rationale: VaR measures the potential loss threshold not exceeded with a
given probability over a set time horizon.
,5. Which distribution is most appropriate for modeling rare, extreme
losses?
A. Normal
B. Uniform
C. Student’s t
D. Lognormal
Rationale: Student’s t-distribution has heavier tails than the normal
distribution, capturing extreme events better.
6. A correlation coefficient of -1 indicates:
A. No relationship between variables
B. Weak positive relationship
C. Perfect negative linear relationship
D. Random relationship
Rationale: A correlation of -1 signifies perfect inverse movement between
two variables.
7. Which of the following risks cannot be diversified away?
A. Firm-specific risk
B. Systematic risk
C. Idiosyncratic risk
, D. Operational risk
Rationale: Systematic risk affects all firms and cannot be eliminated through
diversification.
8. In the CAPM model, the intercept term (alpha) represents:
A. The market return
B. The risk-free rate
C. The abnormal return unexplained by market risk
D. The beta coefficient
Rationale: Alpha is the excess return over that predicted by market
exposure.
9. Which of the following best describes Basel III’s leverage ratio?
A. Ratio of total assets to risk-weighted assets
B. Tier 1 capital divided by total exposure (non-risk weighted)
C. Total capital divided by market risk exposure
D. CET1 capital divided by risk-weighted assets
Rationale: The leverage ratio under Basel III is Tier 1 capital divided by total
exposure, serving as a backstop against excessive leverage.
10. The Sharpe ratio measures:
A. Total portfolio variance
Exam Questions And Correct Answers
(Verified Answers) Plus Rationales 2026
Q&A | Instant Download Pdf
Covers: Foundations of Risk Management, Quantitative Analysis, Financial
Markets & Products, Valuation & Risk Models
1. Which of the following best describes operational risk?
A. Risk of loss from changes in market prices
B. Risk of loss from failed internal processes, people, or systems
C. Risk of default by a counterparty
D. Risk due to liquidity constraints
Rationale: Operational risk arises from failures in internal processes, people,
systems, or external events, distinct from market or credit risk.
2. The primary goal of risk management is to:
A. Eliminate all risks
,B. Optimize risk–return trade-offs
C. Avoid losses entirely
D. Maximize returns
Rationale: Risk management aims to balance risk and return, not eliminate
risk, ensuring the firm takes risks that align with its risk appetite.
3. A bank calculates the expected loss of a loan as 2%. If the exposure is
$10 million, what is the expected loss amount?
A. $100,000
B. $150,000
C. $200,000
D. $250,000
Rationale: Expected loss = Exposure × Expected loss rate = $10,000,000 ×
0.02 = $200,000.
4. Which of the following best defines Value-at-Risk (VaR)?
A. The average loss over a period
B. The maximum potential loss over a specific horizon at a given
confidence level
C. The standard deviation of returns
D. The maximum gain possible
Rationale: VaR measures the potential loss threshold not exceeded with a
given probability over a set time horizon.
,5. Which distribution is most appropriate for modeling rare, extreme
losses?
A. Normal
B. Uniform
C. Student’s t
D. Lognormal
Rationale: Student’s t-distribution has heavier tails than the normal
distribution, capturing extreme events better.
6. A correlation coefficient of -1 indicates:
A. No relationship between variables
B. Weak positive relationship
C. Perfect negative linear relationship
D. Random relationship
Rationale: A correlation of -1 signifies perfect inverse movement between
two variables.
7. Which of the following risks cannot be diversified away?
A. Firm-specific risk
B. Systematic risk
C. Idiosyncratic risk
, D. Operational risk
Rationale: Systematic risk affects all firms and cannot be eliminated through
diversification.
8. In the CAPM model, the intercept term (alpha) represents:
A. The market return
B. The risk-free rate
C. The abnormal return unexplained by market risk
D. The beta coefficient
Rationale: Alpha is the excess return over that predicted by market
exposure.
9. Which of the following best describes Basel III’s leverage ratio?
A. Ratio of total assets to risk-weighted assets
B. Tier 1 capital divided by total exposure (non-risk weighted)
C. Total capital divided by market risk exposure
D. CET1 capital divided by risk-weighted assets
Rationale: The leverage ratio under Basel III is Tier 1 capital divided by total
exposure, serving as a backstop against excessive leverage.
10. The Sharpe ratio measures:
A. Total portfolio variance
