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 61
Which of the following describes 'pipeline risk' in investment banking?
Select an option first.
Correct answer: B — The risk that market conditions deteriorate between when a bank commits to underwrite a deal and when it can distribute the securities
Explanation: Pipeline risk arises in underwriting — when a bank commits to buy securities from an issuer at an agreed price and market conditions move adversely before the securities are sold to investors. A is physical/operational, C is strategic, D is operational/model risk.
Question 62
Which of the following best describes 'headline risk'?
Select an option first.
Correct answer: B — The risk that negative media coverage damages a firm's business regardless of the underlying facts
Explanation: Headline risk is a form of reputational risk — adverse press coverage can trigger customer attrition, rating downgrades, and funding difficulties even if the actual legal or financial exposure is limited.
Question 63
A firm that hedges all of its commodity exposure perfectly and then uses derivatives to speculate on interest rates is:
Select an option first.
Correct answer: C — Replacing one risk with another (potentially unintended) risk
Explanation: Hedging one risk and then adding speculative exposures in another market does not reduce total risk — it replaces the original risk with a different one. This is why risk management requires holistic oversight.
Question 64
Which of the following is an example of a 'knock-on effect' in risk management?
Select an option first.
Correct answer: A — A credit default immediately triggering a margin call, which forces asset sales, which depress prices, affecting other leveraged investors
Explanation: Knock-on (cascade) effects occur when an event triggers a chain of consequences — this is central to understanding systemic risk. B is gradual strategic risk, C is regulatory/operational risk, D is isolated operational risk.
Question 65
Which of the following best characterises 'event risk' in fixed income?
Select an option first.
Correct answer: B — The risk of a sudden, discrete event — such as a leveraged buyout or regulatory action — causing a significant, unanticipated change in a bond's credit quality
Explanation: Event risk in bonds refers to sudden, discontinuous events (M&A, regulatory changes, natural disasters) that abruptly change a bond's credit profile. A is interest rate risk, C is reinvestment risk, D is 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 66
Pension liabilities are best matched with which type of assets from a risk management perspective?
Select an option first.
Correct answer: C — Long-duration, high-quality fixed income assets to match the liability duration
Explanation: Liability-driven investing (LDI) seeks to match the duration and cash flow characteristics of pension liabilities (long, fixed, inflation-linked) with assets of similar characteristics — typically long-dated government or investment-grade bonds.
Question 67
Which of the following statements is correct regarding the relationship between operational risk and the other risk categories?
Select an option first.
Correct answer: A — Operational risk events can trigger credit and market risk losses
Explanation: Operational failures can cascade into credit or market losses — e.g., a rogue trader (operational risk) causes massive market losses. B, C, and D are all incorrect; risks interact.
Question 68
What is the primary purpose of stress testing in risk management?
Select an option first.
Correct answer: C — To assess how a portfolio or institution would perform under severe but plausible adverse scenarios
Explanation: Stress testing explores tail scenarios — recessions, market crashes, rate spikes — to understand vulnerabilities beyond normal statistical models. A is expected loss; B is performance attribution; D is incorrect — stress testing complements, not replaces, VaR.
Question 69
A bank's loan book has an average probability of default (PD) of 2%, a loss given default (LGD) of 50%, and a total exposure of $500 million. What is the expected annual credit loss?
Select an option first.
Correct answer: B — $5 million
Explanation: Expected Loss = PD × LGD × EAD = 2% × 50% × $500m = 1% × $500m = $5 million. A divides incorrectly; C and D use wrong inputs.
Question 70
Which of the following best describes 'model validation'?
Select an option first.
Correct answer: B — An independent review of a model's assumptions, methodology, data inputs, and outputs to ensure it is fit for purpose
Explanation: Model validation is an independent process — typically conducted by a team separate from the model developers — that critically evaluates all aspects of the model to identify weaknesses. A is back-testing (one tool of validation, not the whole process); C and D describe different activities.
Question 71
A risk manager who focuses only on individual risks in isolation without considering how they interact is most likely to:
Select an option first.
Correct answer: B — Underestimate total risk by missing amplifying correlations and compounding effects
Explanation: Risk aggregation across categories often reveals that risks compound — a credit event can trigger market and liquidity impacts simultaneously. Silo-based risk management misses these interactions, typically understating total risk.
Question 72
Which of the following is a characteristic of 'fat-tailed' (leptokurtic) distributions relative to a normal distribution?
Select an option first.
Correct answer: C — More frequent extreme events and heavier tails, making tail risk more significant
Explanation: Fat-tailed (leptokurtic) distributions have excess kurtosis — more of the probability mass is in the tails than under a normal distribution. This means extreme events occur more often than standard models predict, which is a key lesson from financial crises.
Question 73
The concept of RAROC (Risk-Adjusted Return on Capital) is primarily used to:
Select an option first.
Correct answer: B — Allocate capital efficiently by comparing returns across business units on a risk-adjusted basis
Explanation: RAROC = Risk-adjusted return / Economic capital. It standardises performance measurement across business lines with different risk profiles, enabling capital to be allocated to the highest risk-adjusted returns.
Question 74
Which of the following risk types is most directly addressed by the Basel III capital framework?
Select an option first.
Correct answer: B — Credit risk, market risk, and operational risk
Explanation: Basel III (and its predecessors) explicitly quantify and set capital requirements for credit risk, market risk, and operational risk. Reputational and strategic risks are harder to quantify and not directly captured in Pillar 1 minimum capital requirements.
Question 75
A risk manager claims that his firm's aggregate risk is simply the sum of all individual risk positions. This approach is most likely to:
Select an option first.
Correct answer: D — Both A and C are correct
Explanation: Simple addition ignores correlations. When risks are negatively correlated, the sum overstates total risk (diversification benefit is ignored). When correlation is zero, addition equals the correct answer. When positively correlated, sum could overstate unless correlations are +1. So A and C are both correct.
Question 76
Which of the following scenarios best illustrates 'systemic risk amplification through leverage'?
Select an option first.
Correct answer: B — A highly leveraged hedge fund faces margin calls, forcing it to sell assets, depressing prices, triggering more margin calls across the system
Explanation: Leverage amplifies losses and creates systemic feedback loops — forced asset sales create price spirals that affect all leveraged participants. This is the mechanism behind many financial crises. The other options do not demonstrate systemic amplification.
Question 77
Which of the following is the most comprehensive description of 'enterprise risk' that goes beyond simply aggregating individual risks?
Select an option first.
Correct answer: B — The aggregate risk that takes into account interactions between risk types, business strategy, and the firm's capital position
Explanation: True enterprise risk management captures risk interactions, strategy, and capital in a unified view — not just adding up siloed risk measures. ERM recognises that 1 + 1 can equal more than 2 when risks compound and interact.
Question 78
In the context of risk interactions, which of the following best describes how liquidity risk and market risk can reinforce each other?
Select an option first.
Correct answer: B — Forced selling of assets at distressed prices worsens market conditions, which further reduces collateral values and available funding — a self-reinforcing spiral
Explanation: The liquidity-market risk spiral is well-documented: falling prices → margin calls → forced sales → further price falls → further collateral erosion. This was central to the 2007-09 crisis. A and D deny this interaction; C incorrectly generalises.
Question 79
A bank's risk culture can influence which of the following outcomes?
Select an option first.
Correct answer: B — The nature and frequency of operational losses through its impact on risk-taking behaviour and governance
Explanation: Risk culture — values, norms, and behaviours around risk — directly affects how risks are identified, escalated, and managed. Poor risk culture (e.g., incentivising excessive risk-taking) has been linked to major loss events. A, C, and D are all too narrow or dismissive.
Question 80
Which of the following best describes how 'tail dependence' affects portfolio risk?
Select an option first.
Correct answer: A — Assets that are normally independent may become highly correlated during market crises, making diversification less effective precisely when it is most needed
Explanation: Tail dependence captures the tendency for assets to move together in extreme scenarios — correlations spike in crashes, meaning traditional diversification benefits disappear. B, C, D are all incorrect; this is a critical concept for crisis risk management.
Question 81
Reverse stress testing differs from conventional stress testing in that:
Select an option first.
Correct answer: B — It starts from a predefined outcome (e.g., insolvency) and works backwards to identify what combination of events could cause it
Explanation: Reverse stress testing flips the logic: instead of asking 'what loss would scenario X cause?', it asks 'what scenarios would cause the firm to fail?' This is valuable for identifying previously unconsidered vulnerabilities.
Question 82
A risk manager argues that using a single-period VaR model during a crisis underestimates risk. Which of the following best supports this view?
Select an option first.
Correct answer: A — VaR assumes constant correlations, but in crises correlations increase and tail risk grows nonlinearly
Explanation: VaR models often assume stable correlations estimated from normal periods. During crises, correlations spike, volatility jumps, and losses can be much larger than single-period models predict. B, C, D are all incorrect.
Question 83
Which of the following is the most accurate description of 'risk aggregation' across a large financial institution?
Select an option first.
Correct answer: B — A multi-dimensional process of combining risk measures across business lines, asset classes, and geographies while accounting for correlations, model limitations, and data quality
Explanation: Risk aggregation at an institutional level is far more than arithmetic — it must capture portfolio effects, correlation structures, data limitations, and methodological differences. A and C are oversimplified; D is an audit activity, not risk aggregation.
Question 84
Which of the following risks is most directly created by the use of collateralised lending (repo transactions)?
Select an option first.
Correct answer: B — Rehypothecation risk — the risk that collateral pledged by one party is re-used by the receiving party and cannot be returned
Explanation: Rehypothecation occurs when a broker or bank re-uses a client's collateral. If the intermediate party fails, the original pledgor may not recover its assets — this is a specific operational/legal credit risk inherent in collateralised lending chains.
Question 85
A pension fund's investment committee decides to shift a portion of the portfolio into private equity for higher returns. This decision primarily introduces which additional risks?
Select an option first.
Correct answer: B — Illiquidity risk, valuation uncertainty, and leverage risk
Explanation: Private equity introduces illiquidity (cannot easily exit), valuation uncertainty (no transparent market price), and often leverage risk. These risks do not exist to the same degree in liquid public markets. A is wrong — there is no free lunch.
Question 86
Which of the following most accurately describes how 'risk appetite' and 'risk tolerance' differ?
Select an option first.
Correct answer: B — Risk appetite is the desired level of risk the firm wants; risk tolerance is the maximum variation around that desired level that is acceptable
Explanation: Risk appetite is a forward-looking statement of intent (how much risk the firm wants). Risk tolerance is the acceptable band around that appetite — how much deviation is permissible before corrective action is needed. A conflates them; C and D are incorrect.
Question 87
Which of the following best explains why operational risk is harder to model than market or credit risk?
Select an option first.
Correct answer: B — Operational risk lacks a liquid market, historical data is sparse and heterogeneous, and losses are often caused by rare, difficult-to-predict events
Explanation: Operational risk modelling faces fundamental challenges: limited and biased historical data (firms under-report losses), absence of market prices, and the non-repeating nature of events like rogue trading or pandemics. A and C are incorrect; D is far too narrow.
Question 88
In the context of risk interactions, what is meant by 'double default' protection in credit portfolios?
Select an option first.
Correct answer: A — A situation where two separate borrowers must both default before any loss occurs, significantly reducing credit risk
Explanation: Double default refers to situations where both the original borrower AND a guarantor must default before a loss occurs — used in guarantees, unfunded protection. This lowers expected loss dramatically but creates correlation risk if both are exposed to the same factor.
Question 89
A firm's risk manager states: 'Our portfolio is well-diversified because we hold 200 different stocks.' What significant risk remains despite this diversification?
Select an option first.
Correct answer: B — Systematic market risk, which cannot be eliminated through diversification within a single asset class
Explanation: Even a perfectly diversified stock portfolio retains full systematic market risk — the risk that the market as a whole declines. Idiosyncratic risk is substantially reduced with 200+ stocks, but no amount of equity diversification eliminates market beta.
Question 90
What does a 'risk register' typically contain in an enterprise risk management framework?
Select an option first.
Correct answer: B — A comprehensive record of identified risks, their likelihood, potential impact, current mitigants, and responsible owners
Explanation: A risk register is a living document that catalogues risks, assesses their severity (likelihood × impact), records controls and mitigants, and assigns ownership. A is a balance sheet; C is a loss database; D is a capital plan.
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.