You’re on a roll
Create a free account to save your FRM progress, track your accuracy by topic, and pick up right where you left off.
Free Questions › FRM › Foundations of Risk Management
Free FRM Foundations of Risk Management Practice Questions & Answers
400 exam-style Foundations of Risk Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 1
Which of the following best describes 'risk' in a financial context?
Select an option first.
Correct answer: B — The possibility of an outcome deviating from what was expected
Explanation: Risk is fundamentally about uncertainty — the chance that actual outcomes differ from expected ones, in either direction. A is wrong because risk is not a certainty. C describes the opposite (no risk). D is a monetary policy tool, not a definition of risk.
Question 2
Market risk arises primarily from:
Select an option first.
Correct answer: C — Adverse movements in market prices such as interest rates, equity prices, or exchange rates
Explanation: Market risk stems from price movements in financial markets. A describes credit risk. B describes operational risk. D describes reputational risk.
Question 3
Credit risk is best defined as:
Select an option first.
Correct answer: B — The risk that a counterparty will fail to fulfil its financial obligations
Explanation: Credit risk is the danger that a borrower or counterparty defaults. A is interest rate risk (a type of market risk). C is operational risk. D is also market risk.
Question 4
Liquidity risk can be divided into which two broad categories?
Select an option first.
Correct answer: B — Funding liquidity risk and trading (market) liquidity risk
Explanation: Funding liquidity risk is the inability to raise cash to meet obligations; trading liquidity risk is the inability to sell an asset without significant price impact. The other options mix up different risk categories entirely.
Question 5
Operational risk is caused by:
Select an option first.
Correct answer: C — Failures in people, processes, systems, or external events
Explanation: Operational risk is defined by its sources: human error, process failure, system outages, and external events. A is market risk, B is credit risk, D is funding liquidity risk.
Get the full FRM question bank — free
Drop your email and we'll send you fresh FRM practice questions, fully worked solutions and exam-deadline reminders. No spam — unsubscribe in one click.
Want to save your score and take a full mock exam? Create a free account →
Question 6
Reputational risk refers to:
Select an option first.
Correct answer: B — The potential loss in value arising from damage to a firm's standing or public image
Explanation: Reputational risk is about the loss of trust from customers, investors, or the public. A and C are business/strategic risks. D is regulatory/compliance risk, though it may interact with reputational risk.
Question 7
Strategic risk is most closely associated with:
Select an option first.
Correct answer: B — Large, long-term business decisions that may turn out to be wrong
Explanation: Strategic risk involves the possibility that major strategic decisions — such as entering a new market or acquiring a company — prove to be incorrect. A and D are operational risk; C is market (FX) risk.
Question 8
Which of the following is an example of basis risk?
Select an option first.
Correct answer: B — A hedge using a futures contract does not perfectly offset the underlying exposure because the two prices do not move in lockstep
Explanation: Basis risk arises when a hedging instrument and the item being hedged do not move perfectly together, leaving a residual (basis) risk. A is currency risk, C is credit risk, D is operational risk.
Question 9
Which risk type is most relevant when a firm cannot sell a large position in a thinly traded bond without moving the market against itself?
Select an option first.
Correct answer: C — Trading liquidity risk
Explanation: Trading (market) liquidity risk is the inability to exit a position at a fair price because of insufficient market depth. The other options involve different risk drivers.
Question 10
The term 'counterparty risk' is most closely related to:
Select an option first.
Correct answer: C — Credit risk
Explanation: Counterparty risk is a form of credit risk — specifically the risk that the other party in a financial contract (e.g., a derivative) will default before the contract is settled.
Question 11
Which of the following statements about systematic risk is correct?
Select an option first.
Correct answer: C — It represents market-wide risk that cannot be diversified away
Explanation: Systematic (undiversifiable) risk affects the entire market — e.g., recession, interest rate changes. Idiosyncratic (firm-specific) risk can be diversified away, but systematic risk cannot. A and B are incorrect; D is a completely different risk category.
Question 12
Idiosyncratic risk is best described as:
Select an option first.
Correct answer: B — Risk unique to a specific company or asset that can be reduced through diversification
Explanation: Idiosyncratic (unsystematic) risk is firm-specific and can be eliminated by holding a well-diversified portfolio. A describes systematic risk. C is sovereign credit risk. D is interest rate risk.
Question 13
Settlement risk is best described as:
Select an option first.
Correct answer: B — The risk that one party in a transaction delivers but the counterparty fails to deliver its side
Explanation: Settlement risk (also called Herstatt risk) arises when one leg of a transaction is completed but the other is not, leaving one party exposed. C is commodity/market risk; D is operational risk; A is strategic risk.
Question 14
Which of the following best characterises 'model risk'?
Select an option first.
Correct answer: A — The risk that a financial model produces incorrect outputs due to flawed assumptions or errors
Explanation: Model risk arises when models used for pricing, valuation, or risk measurement are built on wrong assumptions, use bad data, or are applied in inappropriate contexts. B is intellectual property risk; C is regulatory risk; D is operational/IT risk.
Question 15
A firm's exposure to natural disasters and pandemics is an example of:
Select an option first.
Correct answer: B — Operational risk arising from external events
Explanation: External event risk — such as natural disasters, pandemics, or terrorist attacks — falls under operational risk. These events affect a firm's operations without being caused by financial market movements (market risk) or counterparty actions (credit risk).
Question 16
Which risk category is most relevant when a government changes tax laws affecting all businesses in an economy?
Select an option first.
Correct answer: C — Systemic/regulatory risk (a form of systematic risk)
Explanation: Changes in tax law affect all firms and represent a form of regulatory or systematic risk. It cannot be diversified away because it applies market-wide. A (idiosyncratic) is firm-specific; B and D are different categories.
Question 17
Funding liquidity risk is most likely to materialise when:
Select an option first.
Correct answer: B — A firm cannot roll over or obtain sufficient short-term financing to meet its obligations
Explanation: Funding liquidity risk is the inability to access cash or credit to meet obligations as they fall due — classic during bank runs or credit crunches. A is market risk; C is actually a positive outcome; D is supply chain / operational risk.
Question 18
Prepayment risk on a mortgage-backed security is an example of which broader risk type?
Select an option first.
Correct answer: B — Market risk (specifically interest rate / optionality risk)
Explanation: Prepayment risk — borrowers repaying mortgages early when rates fall — is a form of market risk driven by interest rate movements and embedded options. The other choices are unrelated risk categories.
Question 19
Which of the following is an example of legal risk?
Select an option first.
Correct answer: A — A lawsuit arising from a contract dispute that was not anticipated at deal inception
Explanation: Legal risk is the risk of loss from legal proceedings, unenforceability of contracts, or regulatory penalties. B is credit risk, C is FX/market risk, D is operational risk.
Question 20
Sovereign risk refers to:
Select an option first.
Correct answer: B — The risk that a national government defaults on its debt or changes rules affecting foreign investors
Explanation: Sovereign risk involves the possibility that a government entity fails to meet its financial obligations or takes actions (e.g., capital controls, expropriation) that harm investors. The other options describe equity, commodity, and operational risks.
Question 21
Which statement about the relationship between risk and return is most accurate?
Select an option first.
Correct answer: B — Investors should demand higher expected returns as compensation for bearing higher risk
Explanation: The fundamental principle is that rational investors require higher expected (not guaranteed) returns for bearing greater risk. A confuses expected with actual returns. C contradicts the risk-return tradeoff. D is incorrect — risk-free assets have the lowest expected returns.
Question 22
The term 'tail risk' refers to:
Select an option first.
Correct answer: B — The risk of extreme outcomes that occur in the tails of a probability distribution
Explanation: Tail risk refers to the low-probability, high-severity events at the extremes of a return distribution. Managing tail risk is critical because normal distribution assumptions often underestimate these events. A and D are incorrect; C is a credit risk variant.
Question 23
Which of the following best describes 'rollover risk'?
Select an option first.
Correct answer: B — The risk that a borrower cannot refinance maturing debt on acceptable terms
Explanation: Rollover risk (a type of funding liquidity risk) is the danger that when short-term debt matures, it cannot be refinanced — either at all or only at prohibitively high rates. A is a futures mechanics issue, C is a judgment/strategy issue, D is yield curve risk.
Question 24
Which of the following best describes 'concentration risk'?
Select an option first.
Correct answer: B — The risk of being overexposed to a single borrower, sector, region, or asset class
Explanation: Concentration risk arises from lack of diversification — excessive exposure to one entity, sector, or geography. The others misrepresent the concept; over-diversification is not typically classified as a risk, and merger issues relate to operational/strategic risk.
Question 25
A bank that relies heavily on short-term wholesale funding to support long-term assets is most exposed to:
Select an option first.
Correct answer: C — Funding liquidity and maturity mismatch risk
Explanation: Funding long-term assets with short-term liabilities creates a maturity mismatch. If wholesale markets freeze, the bank cannot roll over funding — the core of the 2008 crisis for many institutions. The other options are different risk types.
Question 26
Which of the following distinguishes market risk from credit risk?
Select an option first.
Correct answer: B — Market risk arises from price changes in financial markets; credit risk arises from failure to pay obligations
Explanation: Market risk = price/rate movements; credit risk = default or deterioration in counterparty creditworthiness. A reverses the definitions. C is too narrow — market risk applies to rates, FX, commodities, etc. D is incorrect — credit risk can also be hedged via credit derivatives.
Question 27
A food company's exposure to drought causing a rise in wheat prices is primarily which type of risk?
Select an option first.
Correct answer: B — Commodity market risk
Explanation: Commodity price movements (wheat prices in this case) are a form of market risk. The drought is an external trigger, but the financial exposure is to commodity prices. A, C, and D are incorrect in this context.
Question 28
Which of the following risks arises when a firm executes a transaction in an overseas subsidiary that is subject to local capital controls?
Select an option first.
Correct answer: A — Legal and regulatory (sovereign) risk
Explanation: Capital controls imposed by a sovereign government create legal and sovereign risk for the firm — the inability to repatriate funds or complete transactions as planned. The other options do not capture the government-imposed restriction dimension.
Question 29
Interest rate risk is a subset of which broader risk category?
Select an option first.
Correct answer: C — Market risk
Explanation: Interest rate risk — the risk of loss from changes in interest rates — is a type of market risk alongside equity, FX, and commodity risk. It is not operational, credit, or liquidity risk.
Question 30
Foreign exchange (FX) risk primarily affects a company when:
Select an option first.
Correct answer: B — It has revenues, costs, or assets denominated in currencies different from its reporting currency
Explanation: FX risk arises from currency mismatches — the company's financial results are affected by exchange rate movements when transactions or balance sheet items are in foreign currencies. A mislabels the direction; C is supply chain risk; D is equity price risk.
More free FRM topics
Ten questions in
- The ones you miss are saved as a drill you can repeat
- Your place is kept, on this device and any other
- A streak, if that is the thing that gets you back tomorrow
Every question on this page stays free and open either way.