Exam Questions And Correct Answers

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

• Which of the following best describes operational risk?
• Risk of loss from changes in market prices
• Risk of loss from failed internal processes, people, or systems
• Risk of default by a counterparty
• 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:

• Eliminate all risks 1 / 4

• Optimize risk–return trade-offs
• Avoid losses entirely
• 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.

• 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.

• Which of the following best defines Value-at-Risk (VaR)?
• The average loss over a period
• The maximum potential loss over a specific horizon at a given

confidence level

• The standard deviation of returns
• The maximum gain possible

Rationale: VaR measures the potential loss threshold not exceeded with a

given probability over a set time horizon. 2 / 4

• Which distribution is most appropriate for modeling rare, extreme

losses?

• Normal
• Uniform
• Student’s t
• Lognormal

Rationale: Student’s t-distribution has heavier tails than the normal

distribution, capturing extreme events better.

6. A correlation coefficient of -1 indicates:

• No relationship between variables
• Weak positive relationship
• Perfect negative linear relationship
• Random relationship

Rationale: A correlation of -1 signifies perfect inverse movement between

two variables.

• Which of the following risks cannot be diversified away?
• Firm-specific risk
• Systematic risk
• Idiosyncratic risk 3 / 4

• Operational risk

Rationale: Systematic risk affects all firms and cannot be eliminated through

diversification.

8. In the CAPM model, the intercept term (alpha) represents:

• The market return
• The risk-free rate
• The abnormal return unexplained by market risk
• The beta coefficient

Rationale: Alpha is the excess return over that predicted by market

exposure.

• Which of the following best describes Basel III’s leverage ratio?
• Ratio of total assets to risk-weighted assets
• Tier 1 capital divided by total exposure (non-risk weighted)
• Total capital divided by market risk exposure
• 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:

• Total portfolio variance
• / 4