FRM Part II practice questions

Question 1

A portfolio has a 1-day 99% VaR of $2.5m. Assuming i.i.d. returns, the 10-day 99% VaR is closest to:

1. A$7.9m
2. B$25.0m
3. C$2.5m
4. D$5.0m

Question 2

A bank’s 99% 1-day VaR model produced 9 exceptions in 250 trading days. This most likely indicates:

1. AThe model overstates risk
2. BThe model is well calibrated
3. CThe model understates risk
4. DNothing without expected shortfall data

Question 3

Breaches of a VaR model cluster in a single stressed week rather than occurring evenly. The most appropriate test is:

1. AKupiec's unconditional coverage test
2. BChristoffersen's conditional coverage test
3. CA Jarque–Bera normality test
4. DA Dickey–Fuller unit root test

Question 4

In extreme value theory using the peaks-over-threshold approach, a positive shape parameter ξ indicates:

1. ATails thinner than the normal distribution
2. BTails fatter than the normal distribution
3. CA bounded loss distribution
4. DThat the threshold was set too low

Question 5

The Gaussian copula was widely criticised after 2008 primarily because it:

1. ACannot join different marginal distributions
2. BExhibits zero tail dependence
3. CRequires equal marginals for all variables
4. DCannot be calibrated to market data

Question 6

Under the Merton model, an increase in the volatility of the firm’s assets will:

1. AIncrease equity value and decrease default probability
2. BIncrease equity value and increase default probability
3. CDecrease equity value and increase default probability
4. DLeave equity value unchanged

Question 7

Holding individual default probabilities constant, an increase in default correlation across a credit portfolio will:

1. AIncrease expected loss and increase credit VaR
2. BLeave expected loss unchanged and increase credit VaR
3. CIncrease expected loss and leave credit VaR unchanged
4. DReduce both measures

Question 8

A bank buys credit protection on a sovereign from a bank domiciled in that same sovereign. This is a clear example of:

1. ARight-way risk
2. BWrong-way risk
3. CBasis risk
4. DSettlement risk

Question 9

In a CDO structure, an increase in default correlation across the collateral pool will most likely:

1. ABenefit the equity tranche and harm the senior tranche
2. BHarm the equity tranche and benefit the senior tranche
3. CBenefit both tranches
4. DHave no effect on either tranche

Question 10

Which mechanism most directly reduces counterparty credit exposure without changing the underlying trades?

1. AIncreasing the notional
2. BClose-out netting and collateral agreements
3. CExtending the maturity
4. DWidening the credit spread charged

Question 11

In a loss distribution approach, operational loss frequency is most commonly modelled with:

1. AA lognormal distribution
2. BA Poisson distribution
3. CA generalised Pareto distribution
4. DA Student t distribution

Question 12

A firm’s risk management function both designs the control framework and performs the independent assurance review of it. This most directly compromises:

1. AThe first line of defence
2. BThe separation of the second and third lines of defence
3. CThe board's risk appetite statement
4. DThe RCSA process only

Question 13

A model validated successfully on historical data fails badly in a new market regime. This is best classified as a failure of:

1. AImplementation accuracy
2. BConceptual soundness
3. CData quality controls
4. DChange management

Question 14

A firm outsources a critical process to a third party that suffers an outage. Regulatory accountability for the disruption rests with:

1. AThe third party alone
2. BThe firm, which cannot outsource accountability
3. CBoth parties equally by default
4. DNeither, if the contract contains a force majeure clause

Question 15

Internal loss data alone is generally insufficient for operational risk capital because it:

1. AIs not audited
2. BIs too sparse in the tail to estimate extreme severity
3. COverstates high-frequency low-severity events
4. DCannot be used under Basel rules

Question 16

A position worth $50m has a VaR of $2m and a bid–ask spread of 0.40%. Liquidity-adjusted VaR using the exogenous spread approach is closest to:

1. A$2.00m
2. B$2.10m
3. C$2.20m
4. D$4.00m

Question 17

The liquidity coverage ratio requires a bank to hold high-quality liquid assets sufficient to cover net cash outflows over:

1. A5 days
2. B30 days
3. C90 days
4. DOne year

Question 18

A fund forced to sell assets to meet redemptions depresses prices, triggering further redemptions and further sales. This is best described as:

1. ABasis risk
2. BA liquidity spiral
3. CWrong-way risk
4. DRegulatory arbitrage

Question 19

Without funds transfer pricing, a bank’s long-dated lending business will most likely appear:

1. ALess profitable than it is, because liquidity cost is over-allocated
2. BMore profitable than it is, because liquidity cost is not charged to it
3. CCorrectly priced, since liquidity cost is a central function
4. DUnaffected, since FTP is an accounting convention only

Question 20

Which asset receives no haircut in the LCR high-quality liquid asset calculation?

1. ALevel 1 assets
2. BLevel 2A assets
3. CLevel 2B assets
4. DAll HQLA receive the same haircut

Question 21

A small allocation to an asset with high volatility and high correlation to the rest of the portfolio can dominate the risk budget. The measure that reveals this is:

1. AThe position weight
2. BMarginal contribution to risk
3. CThe Sharpe ratio of the position
4. DThe position's standalone volatility

Question 22

When a hedge fund joins an index, the index provider adds the fund’s prior track record. The resulting distortion is:

1. ASurvivorship bias
2. BBackfill bias
3. CSelection bias in the risk-free rate
4. DSmoothing bias

Question 23

Reported returns on an illiquid private portfolio display strong positive autocorrelation. Unsmoothing the series will:

1. ALower the estimated volatility and raise the Sharpe ratio
2. BRaise the estimated volatility and lower the Sharpe ratio
3. CLeave volatility unchanged but raise correlation
4. DLower both volatility and correlation

Question 24

Factor theory holds that assets earn a risk premium because they:

1. ABelong to a particular asset class
2. BPerform poorly in bad times
3. CHave high historical volatility
4. DAre held by institutional investors

Question 25

A manager reports strong alpha, but a factor regression shows most of the excess return is explained by a persistent value tilt. The appropriate conclusion is that the return reflects:

1. AGenuine manager skill
2. BSystematic factor exposure available more cheaply
3. CA backtesting error
4. DSurvivorship bias in the benchmark

Question 26

The Current Issues topic differs from every other FRM topic area because it:

1. AIs not examined
2. BIs replaced substantially each exam cycle
3. CContains only quantitative material
4. DCarries the largest weight in Part II

Question 27

The principal supervisory concern with machine learning models used in credit decisions is:

1. ATheir computational cost
2. BLimited explainability and the resulting model governance gap
3. CTheir inability to handle large datasets
4. DThat they cannot be backtested

Question 28

A scenario describing rapid, well-signalled decarbonisation policy is best characterised as:

1. AHigh physical risk and low transition risk
2. BLow physical risk and high transition risk
3. CHigh physical and high transition risk
4. DLow physical and low transition risk

Question 29

The 2023 US regional banking stress is best explained by the interaction of:

1. ACredit losses on commercial loans and inadequate provisions
2. BUnrealised duration losses and concentrated, digitally mobile uninsured deposits
3. COperational failures in payment systems
4. DCounterparty defaults in the derivatives market

Question 30

A key financial stability concern with fiat-referenced stablecoins is that they:

1. ACannot be transferred across borders
2. BAre subject to run dynamics if reserve quality or redemption is doubted
3. CPay a variable interest rate to holders
4. DAre always fully insured by deposit schemes