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Free FRM Risk Management & Investment Management Practice Questions & Answers
400 exam-style Risk Management & Investment 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
What is 'volatility risk premium' (VRP) and how is it captured?
Select an option first.
Correct answer: B — The observed tendency for implied volatility (options market pricing) to exceed realised volatility — selling options (e.g., selling variance swaps, writing put options) earns this premium systematically. The VRP exists because options buyers pay a fear premium for protection
Explanation: B is correct. Volatility risk premium: implied vol > realised vol on average (~2-4 vol points in equity indices). The premium compensates sellers for bearing tail risk. Strategies: (1) Short variance swaps; (2) Covered call writing; (3) Put selling. Risk: short gamma — small gains most of the time, large losses during market crises (short options profits in the COVID crash were wiped out). A reverses who earns the premium. C is the opposite. D is the vol gap.
Question 392
What is 'private debt' (private credit) as an asset class?
Select an option first.
Correct answer: B — Loans and debt instruments originated and held by non-bank lenders (e.g., direct lending funds, mezzanine funds, distressed debt funds) — offers: illiquidity premium over public bonds, floating rate (rising rate protection), stronger covenants, and direct lender control. Fills the gap left by banks retreating from leveraged lending
Explanation: B is correct. Private credit: has grown significantly post-2008 as banks reduced corporate lending. Sub-categories: direct lending (senior secured to mid-market companies), mezzanine (subordinated, higher yield), distressed debt, specialty finance. Returns: LIBOR/SOFR + 500-700bps for senior direct lending. Risks: illiquidity, concentration, covenant quality. A is syndicated bank debt. C describes high-yield bonds. D is not private credit.
Question 393
What is 'duration matching' in a pension fund context?
Select an option first.
Correct answer: B — Adjusting the bond portfolio's interest rate sensitivity (duration) to match the duration of pension liabilities — so that when interest rates change, the value of assets and liabilities move proportionally, stabilising the funded status (surplus = assets − PV of liabilities)
Explanation: B is correct. Duration matching in LDI: pension liability duration is often 15-25 years for a mature pension fund. If bond portfolio duration = 8 years (much shorter), a fall in rates increases liability value more than asset value → funded status deteriorates. LDI overlays (long-dated swaps, gilt strips) extend effective duration to match liabilities. A is demographic matching. C is cashflow matching. D is incorrect.
Question 394
What is 'negative convexity' and which asset class commonly exhibits it?
Select an option first.
Correct answer: B — A property where the price-yield relationship curves downward — the asset gains less in price when yields fall than it loses when yields rise by the same amount. Most commonly exhibited by mortgage-backed securities (MBS) with prepayment options and callable bonds
Explanation: B is correct. Negative convexity (MBS): when rates fall, homeowners prepay (the option is exercised), capping price appreciation. When rates rise, prepayments slow, extending duration and amplifying price decline. This asymmetric payoff = negative convexity. Callable bonds have the same property (issuer calls when rates fall). Regular government bonds have positive convexity. A is just asymmetry. C and D are incorrect.
Question 395
What is 'commodity index roll methodology' and why does it affect returns?
Select an option first.
Correct answer: B — The calculation of commodity spot prices
Explanation: B is correct. Roll methodology: standard indices (GSCI, BCOM) roll monthly into nearby contracts. In persistent contango (natural gas, oil), this generates significant negative roll returns. Alternative indices: maximum roll yield indices roll into the contract with the best carry (most backwardated point). The choice of roll methodology can create 5%+ annual return difference in contango markets. A is the definition. C is rebalancing. D is delivery.
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Question 396
What is 'NAV premium or discount' in closed-end funds?
Select an option first.
Correct answer: B — Closed-end funds trade on stock exchanges at prices that may differ from the underlying NAV — a discount (price < NAV) may reflect: management concerns, illiquid underlying assets, poor performance, or overhang of sellers. A premium (price > NAV) may reflect: popular strategy, leverage, or scarcity of exposure
Explanation: B is correct. Closed-end fund discount/premium: unlike open-end funds (always priced at NAV), closed-end funds issue a fixed number of shares that trade on exchanges. Historical average: closed-end funds trade at ~5-10% discount to NAV. Arbitrage opportunity: closed-end fund activists may push for wind-up or open-ending to realise the discount. A is a fee concept. C is a management fee. D is return calculation.
Question 397
What is 'market microstructure' and why does it matter for institutional investors?
Select an option first.
Correct answer: B — The study of how trading mechanisms, order types, market makers, and information asymmetry affect price formation and transaction costs — institutional investors face microstructure costs when executing large orders: market impact, adverse selection (trading against informed traders), bid-ask spreads
Explanation: B is correct. Market microstructure: when a large pension fund buys $1B of a single stock, it moves the price against itself. Market microstructure analysis: optimal execution (slice orders, use algorithms, time trading), dark pools (reduced market impact), smart order routing. Institutional investors use transaction cost analysis (TCA) to measure microstructure costs. A is monetary policy. C is organisational structure. D is a specific market application.
Question 398
What is 'risk premium arbitrage' in fixed income?
Select an option first.
Correct answer: B — Exploiting differences in risk premiums between similar securities that should command the same spread — for example, two BBB-rated bonds with identical maturities but from different issuers trading at different spreads, where the difference reflects temporary supply/demand or information asymmetry rather than real credit quality differences
Explanation: B is correct. Fixed income relative value: similar credits temporarily priced differently due to: market segmentation, different investor bases, liquidity differences, or structural factors. The arbitrageur buys the cheaper (higher-yielding) credit and sells the more expensive one, expecting convergence. This is a major institutional investor and hedge fund strategy. A describes a perfect hedge. C is bond valuation. D is diversification.
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