FRM FRM Operational Risk 2 — Questions and Answers
Question 1: What is the 'four-eyes principle' in operational risk controls?
- Requiring two people to authorize significant transactions or decisions to prevent fraud and errors (Correct answer)
- Mandating that all risk reports are reviewed by both front office and risk management
- Establishing dual reporting lines for traders to both the desk head and CRO
- Requiring two independent systems to validate the same transaction simultaneously
Correct answer: Requiring two people to authorize significant transactions or decisions to prevent fraud and errors
The four-eyes principle is a segregation of duties control requiring a second authorized person to approve important actions, reducing the risk of unauthorized activity.
Question 2: In operational risk loss data, what are 'near misses'?
- Events that could have caused losses but were caught before any financial impact occurred (Correct answer)
- Operational losses below the reporting threshold excluded from capital models
- Events where the actual loss was close to the modeled expected loss
- Transactions that failed to settle but were subsequently corrected without loss
Correct answer: Events that could have caused losses but were caught before any financial impact occurred
Near misses are operational risk events that were averted or caught before causing financial loss; they provide valuable data about control weaknesses.
Question 3: Which of the following is an example of 'execution, delivery, and process management' as an operational risk event type under Basel?
- A settlement error resulting from incorrect trade data entry (Correct answer)
- A rogue trader deliberately hiding trading losses from management
- A bank robbery at a retail branch location
- A cyberattack that exfiltrates customer account data
Correct answer: A settlement error resulting from incorrect trade data entry
Execution, delivery, and process management covers unintentional failures in transaction processing, settlement errors, and data entry mistakes.
Question 4: What does 'Business Continuity Planning' (BCP) protect against in operational risk management?
- Disruption to critical business functions from disasters, system failures, or other major operational events (Correct answer)
- Unexpected increases in credit losses during economic downturns
- Regulatory fines from failure to meet capital adequacy requirements
- Counterparty default on over-the-counter derivatives contracts
Correct answer: Disruption to critical business functions from disasters, system failures, or other major operational events
BCP ensures that critical operations can continue or be quickly restored following a disruptive event such as a natural disaster, power failure, or pandemic.
Question 5: What is 'model risk' in the context of operational risk?
- The risk of loss from decisions based on incorrect or misused financial models (Correct answer)
- The risk that a bank's internal rating model overestimates borrower creditworthiness
- The risk that market risk VaR models underestimate tail losses during crises
- The risk that regulatory capital models produce inconsistent results across banks
Correct answer: The risk of loss from decisions based on incorrect or misused financial models
Model risk arises when models have errors, are misapplied, or their assumptions break down, leading to incorrect valuations or decisions that cause financial loss.
Question 6: Under the Basel III Standardized Measurement Approach (SMA) for operational risk, the capital charge is based on:
- A combination of a business indicator component and an internal loss multiplier (Correct answer)
- The 99.9th percentile of modeled operational losses from internal data
- A fixed percentage of total assets regardless of operational risk profile
- The sum of regulatory capital charges across all seven Basel event type categories
Correct answer: A combination of a business indicator component and an internal loss multiplier
SMA combines a Business Indicator Component (based on income and activity measures) with an Internal Loss Multiplier that adjusts for a bank's own loss history.
FRM FRM Operational Risk 2
What is the 'four-eyes principle' in operational risk controls?