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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 391
The concept of 'regulatory capital arbitrage' in banking historically led to which outcome?
Select an option first.
Correct answer: B — Banks structured transactions to reduce regulatory capital requirements without genuinely reducing underlying economic risk, leading to a misalignment between measured and actual risk
Explanation: Capital arbitrage: banks moved assets off-balance-sheet (SIVs, conduits) to reduce RWA and capital requirements while retaining economic risk through liquidity backstops. This was a major factor in the 2008 crisis — the risk had not disappeared, it was hidden. Basel reforms (BCBS 239, revised securitisation framework) addressed this.
Question 392
A pension fund is described as 'fully funded.' This means:
Select an option first.
Correct answer: B — The present value of the fund's assets equals or exceeds the present value of its liabilities
Explanation: Funding ratio = PV(Assets) / PV(Liabilities). A ratio ≥ 100% means the fund is fully funded. This is sensitive to the discount rate used to value liabilities — a key risk for pension funds when interest rates change. A is asset allocation; C is sovereign guarantee; D is future contributions (not solvency).
Question 393
Which of the following best describes a 'liability-driven investment (LDI) overlay' strategy?
Select an option first.
Correct answer: B — Using interest rate swaps, swaptions, or long-dated bonds as a separate overlay to hedge the interest rate sensitivity of liabilities, while maintaining a separate return-seeking portfolio
Explanation: LDI overlay: a separate hedging portfolio (interest rate and inflation swaps) is maintained to reduce liability sensitivity, while the 'growth' portfolio (equities, alternatives) seeks returns to close the funding gap. This separates the hedging objective from the return-seeking objective.
Question 394
Which of the following is a primary benefit of 'netting' in derivatives markets?
Select an option first.
Correct answer: B — Bilateral netting reduces counterparty credit exposure by offsetting positive and negative MTM values across all contracts with the same counterparty, reducing gross exposure to a net figure
Explanation: Netting (via ISDA master agreements) transforms gross bilateral exposures into net exposures — if Party A owes Party B $10m and Party B owes Party A $7m, the net exposure is $3m. This dramatically reduces credit risk in large derivative portfolios. A, C, and D are all incorrect.
Question 395
Under Basel III, the 'risk weight' applied to an asset when calculating risk-weighted assets (RWA) is intended to:
Select an option first.
Correct answer: B — Reflect the riskiness of the asset, so that riskier assets consume more regulatory capital
Explanation: Risk weights convert nominal asset amounts into RWA: a 0% risk weight for government bonds (no capital), 20% for OECD bank claims, 100% for corporate loans (standard approach). Higher risk weights on riskier assets ensure more capital is held against them. A, C, and D are not determinants of risk weights.
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Question 396
Which of the following best describes the purpose of the 'capital conservation buffer' during a period when a bank's CET1 ratio falls into the buffer range?
Select an option first.
Correct answer: B — The bank faces automatic restrictions on distributions (dividends, share buybacks, discretionary bonuses) until the buffer is rebuilt, incentivising capital conservation
Explanation: When CET1 falls into the CCB range (4.5%–7.0%), the distribution restriction mechanism activates automatically — the proportion of earnings that can be distributed decreases as CET1 falls deeper into the buffer. This creates an automatic capital-building incentive without immediate resolution. A is too drastic; C is wrong; D contradicts the CCB's purpose.
Question 397
A firm's CRO presents the board with a 'risk dashboard' covering all major risk categories. What is the most important characteristic of an effective risk dashboard?
Select an option first.
Correct answer: B — It should provide a clear, timely, and actionable summary of the firm's most material risk exposures relative to appetite, highlighting exceptions and emerging risks
Explanation: Effective risk dashboards: clear (not overwhelming), timely (actionable before positions change), focused on material risks, and show status relative to appetite/limits with trend indicators. A (too much data) creates noise; C (no qualitative) misses context; D (quarterly) may be too infrequent for market/liquidity risks.
Question 398
Which of the following statements most accurately describes the relationship between a firm's risk appetite and its business strategy?
Select an option first.
Correct answer: B — Risk appetite and business strategy should be aligned — the board sets risk appetite as part of strategic planning, ensuring the firm only pursues strategies whose risk profile falls within its approved appetite
Explanation: Best practice: risk appetite is integrated into strategic planning. A strategy that exceeds risk appetite should be modified or rejected. A describes a risk-blind approach; C is incorrect (regulators set minimum standards, not firm-specific appetite); D creates dangerous misalignment.
Question 399
Which of the following is the most significant governance lesson from the collapse of Barings Bank in 1995?
Select an option first.
Correct answer: B — The failure of segregation of duties — allowing one individual (Nick Leeson) to control both trading and back-office functions — created an unchecked opportunity for fraud and loss concealment that went undetected until it was too late
Explanation: Barings: Leeson had unusual dual responsibility for both executing trades and overseeing the settlement/back-office function. This allowed him to hide losses in a secret account ('88888') for years. The lesson is fundamental: no individual should control both risk-generation and risk-control functions. A is too broad; C and D misidentify the cause.
Question 400
A firm's risk management team identifies that its counterparty credit exposure is highly concentrated in one sector. The most appropriate risk governance response is:
Select an option first.
Correct answer: B — Reporting the concentration to the relevant risk committee, assessing it against established concentration limits, and — if limits are breached — developing a plan to reduce exposure within a defined timeframe
Explanation: Proper governance: identify → measure → escalate → manage. The risk committee reviews against limits, and a remediation plan is developed if limits are breached. A is too hasty (uneconomical); C violates governance obligations; D amplifies the problem.
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