FRM® Practice Quiz and Sample Questions

If you’re preparing for the Financial Risk Manager (FRM®) Exam, you already know that memorizing formulas isn’t enough. The exam tests how well you can apply financial risk management concepts to markets, crises, and business decisions. Candidates typically invest around 240 hours of study time over several months when preparing for the FRM® exam, though this varies by background and experience.

Luckily, I’m here to help. In this quick guide, I’ve included 20 practice questions with answer explanations to give you some practice time and boost your chances of passing.

Key Takeaways

• The FRM® Exam Tests Real-World Risk: Questions focus on market risk, credit risk, liquidity risk, operational risk, and stress testing, not simple memorization.
• Quantitative Concepts Are Essential: Expect calculations involving VaR, standard deviation, default probability, and normal distribution assumptions.
• Model Limitations Matter: Understanding when risk models fail, especially in extreme but plausible scenarios, is heavily tested.
• Practice Questions Improve Accuracy: Consistent practice strengthens decision-making, time management, and your ability to choose the correct answer.
• Scenario-Based Thinking Is Required: You’ll be expected to evaluate financial events, system failures, and portfolio shocks the same way a risk professional would.

FRM® Exam Structure at a Glance

FRM® Part I focuses on the foundations of risk management, quantitative analysis, derivatives, and valuation.

Expect topics like:

• Central limit theorem
• Normal distribution
• Standard deviation
• Risk-free rate
• Capital asset pricing model
• Value at risk (VaR)
• Historical simulation
• Equally weighted returns

FRM® Part II focuses more heavily on application, covering:

• Credit risk measurement
• Operational risk management
• Market risk
• Stress testing
• Scenario analysis
• Liquidity risk
• Treasury risk
• Extreme but plausible scenarios

The exam’s primary function is to test whether you can evaluate systematic risk, interpret risk models, and advise real-world institutions like hedging desks, pension funds, banks, or asset managers.

Why Quantitative Analysis Matters

Risk is not a philosophy; it’s a measurement. Most valuation and risk models rely on probability distributions and sensitivity testing.

For example:

• Expected return under CAPM uses the risk-free rate plus systematic market exposure.
• Expected loss on a loan portfolio multiplies exposure × probability of default × loss given default.
• Value at risk (VaR) estimates the maximum potential loss at a stated confidence level.

These tools help model volatility, market turbulence, and portfolio shocks, especially during financial crisis environments (think 2008 or 2020). On exam day, you will repeatedly interpret which risk measure is most appropriate for a given portfolio or business scenario.

FRM® Sample Questions

Part I: Foundations, Quant, and Market Risk (Q1–Q10)

1. Under CAPM, which variable captures the sensitivity of a portfolio to systematic risk?

A. Alpha
B. Beta
C. Standard deviation
D. Correlation coefficient

Correct Answer: B
Explanation: Beta measures exposure to market-wide (systematic) risk relative to the market portfolio.

2. A pension fund has a long equity portfolio. Which interest rate scenario increases its market risk the most?

A. Rising rates
B. Falling rates
C. Stable rates
D. No change in volatility

Correct Answer: A
Explanation: Rising rates increase discount factors and reduce asset valuations, especially for long-duration portfolios.

3. A risk manager uses the central limit theorem to justify VaR estimation. What must be true?

A. Returns must be independent and identically distributed (i.i.d.)
B. Sample size must equal 30
C. The portfolio must be hedged
D. The market must be efficient

Correct Answer: A
Explanation: CLT requires independent, identically distributed random variables; a large sample size makes the normal approximation stronger.

4. If daily returns have fat tails, which VaR method is most appropriate?

A. Parametric VaR with normal distribution
B. Parametric VaR with t-distribution
C. Simple standard deviation
D. Confidence level = 50%

Correct Answer: B
Explanation: t-distribution VaR handles kurtosis better than Gaussian VaR.

5. A bank holds USD assets and foreign liabilities. The local currency depreciates. What risk applies?

A. Operational risk
B. Market risk
C. Model risk
D. Systemic risk

Correct Answer: B
Explanation: Currency movements affect asset/liability values and fall under market risk, not operational or systemic categories.

6. What is the primary objective of stress testing?

A. To find the average return
B. To estimate the probability of default
C. To confront portfolios with extreme but plausible scenarios
D. To calibrate VaR models

Correct Answer: C
Explanation: Stress testing evaluates how portfolios react to rare, severe market events.

7. Which risk measure identifies how much capital may be needed to withstand losses?

A. Beta
B. Duration
C. VaR
D. Correlation

Correct Answer: C
Explanation: VaR estimates the potential loss over a given period and helps determine required capital reserves.

8. In a historical simulation VaR approach, which weighting scheme is most basic?

A. EWMA
B. Exponentially weighted
C. Equally weighted
D. GARCH

Correct Answer: C
Explanation: Historical simulation typically treats past returns with equal weight unless otherwise adjusted.

9. A bond portfolio manager wants to quantify exposure to interest rate changes. Which measure is most relevant?

A. LGD
B. Duration
C. Convexity ratio
D. Expected return

Correct Answer: B
Explanation: Duration measures interest rate sensitivity, making it key for bond risk.

10. A heavy-tailed return distribution violates which assumption of the simple parametric VaR model?

A. Homoscedasticity
B. Normality
C. Independence
D. Liquidity

Correct Answer: B
Explanation: Parametric VaR assumes normal returns, which fat tails violate.

Part II: Operational, Credit, Liquidity, and Risk Applications (Q11–Q20)

11. Which is NOT an example of operational risk?

A. Rogue trading
B. Bad pricing model
C. Cyber breach
D. Interest rate hike by the Fed

Correct Answer: D
Explanation: Interest rates are market risk; other failures are internal or system-based.

12. A bank calculating expected loss on a loan portfolio should use:

A. Exposure × PD × LGD
B. Beta × Duration
C. Alpha × sigma²
D. Coupon ÷ VaR

Correct Answer: A
Explanation: This formula estimates credit losses under expected conditions.

13. Counterparty risk is most relevant to:

A. Fully paid equity holdings
B. Futures contract margining
C. OTC swaps
D. Sovereign treasuries

Correct Answer: C
Explanation: OTC derivatives create bilateral exposure that depends on counterparties’ performance.

14. A liquidity coverage ratio requires banks to hold:

A. Long-dated equities
B. Private RE funds
C. High-quality liquid assets
D. Junk bonds

Correct Answer: C
Explanation: LCR rules require easy-to-sell assets for 30-day liquidity needs.

15. Which scenario best describes systematic risk?

A. A trader’s computer crashes
B. A firm loses its CFO
C. The oil market collapses, and global equities fall
D. A branch employee commits fraud

Correct Answer: C
Explanation: Systematic risk affects the entire market and cannot be diversified away.

16. In financial crisis stress testing, the hardest variable to model is often:

A. Daily volume
B. Cost of capital
C. Correlation breakdown
D. Nominal exchange rate

Correct Answer: C
Explanation: During crises, asset correlations converge toward 1, destroying diversification assumptions.

17. A risk manager at a commodity producer hedges basis risk by:

A. Holding identical spot contracts
B. Using futures on a related but imperfect underlying
C. Buying volatility swaps
D. Issuing corporate bonds

Correct Answer: B
Explanation: Basis risk arises when hedging with non-identical instruments.

18. Which approach best measures credit risk for a diversified portfolio?

A. Scenario analysis tied to macro shocks
B. Flat spread curves
C. CAPM beta decomposition
D. Standard deviation of historical prices

Correct Answer: A
Explanation: Portfolio credit risk requires stress events and correlated defaults, not single-name variance.

19. What is the downside of relying solely on VaR?

A. It is too conservative
B. It ignores tail losses beyond the confidence level
C. It requires too many simulations
D. It cannot handle time series

Correct Answer: B
Explanation: VaR doesn’t account for extreme losses beyond its cutoff.

20. A bank experiences system failures that prevent trade settlement. What risk category is this?

A. Treasury risk
B. Operational risk
C. Liquidity risk
D. Pension fund risk

Correct Answer: B
Explanation: Internal process failures fall under operational risk.

Why Real-World Context Matters

Risk professionals don’t work in a vacuum. Banks, hedge funds, and asset managers apply these concepts daily. When evaluating a loan portfolio or a swap book, you don’t ask abstract questions; you test plausible scenarios:

• What if credit spreads widen?
• What if volatility spikes?
• What if our counterparty defaults?

These kinds of questions appear on the FRM® exam, so familiarize yourself with questions like these.

Exam Day Strategy: How to Choose the Correct Answer

1. Predict first.
   Before reading the choices, think of the primary objective of the question.
2. Eliminate extremes.
   Answers containing “always” or “never” rarely work in risk modeling.
3. Select contextually correct models.
   Choose the appropriate test:

• Normal distribution for large populations
• Historical simulation when returns are skewed
• CAPM for beta-based expected return

4. Use consistent practice.
   Stacking practice questions, mock exams, and sample questions builds intuition.
5. Don’t over-memorize.
   Risk is probabilistic, not absolute.

What Makes FRM® Sample Questions Unique?

Unlike traditional finance exams, FRM® questions mirror real scenarios you’d encounter as a financial risk manager. Rather than asking you to plug numbers into a fixed formula, the exam pushes you to understand context:

• Market Risk Measurement: How interest rates, currencies, or futures contracts affect portfolios
• Credit Risk Measurement: Default probability, expected loss, and credit exposure
• Operational Risk: System failures, human error, cyberattacks, and internal process breakdowns
• Liquidity Risk: Ability to meet obligations using high-quality liquid assets and the liquidity coverage ratio

The primary objective of the FRM® exam is to determine whether you can manage downside risk using core principles, not memorize definitions.

FRM® Exam Preparation Tips

FRM® candidates succeed when they balance theory with application:

• Study the foundations of risk management first
• Practice scenario analysis, not just flashcard-style memorization
• Work backward from real-world failures like financial crisis case studies
• Review stress testing frameworks like the liquidity coverage ratio

Final Thoughts

The FRM® exam challenges your ability to think. Whether you’re modeling basis risk on underlying assets or determining scenario losses for a loan portfolio, the exam rewards candidates who can interpret risk, not memorize it.

If you take away one message, let it be this: consistent practice and real-world thinking are the key. Combine mock exams, a steady practice quiz routine, and sample questions grounded in markets. Build intuition, not just notes. With strategic preparation, you’re not just studying for the FRM®; you’re learning to become a financial risk manager who can protect capital in volatile markets.

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