FRM FRM Operational Risk 1 — Questions and Answers
Question 1: How does Basel II define operational risk?
- The risk of loss resulting from inadequate or failed internal processes, people, systems, or external events (Correct answer)
- The risk of loss from unexpected changes in interest rates and market prices
- The risk of financial loss from counterparty default on an obligation
- The risk that liquidity is insufficient to meet short-term obligations
Correct answer: The risk of loss resulting from inadequate or failed internal processes, people, systems, or external events
Basel II defines operational risk narrowly to exclude market and credit risk, focusing on failures in people, processes, systems, and external events such as natural disasters.
Question 2: Which of the following is an example of an internal fraud operational risk event?
- A rogue trader concealing losses through unauthorized transactions (Correct answer)
- A data center outage caused by a hurricane
- A vendor failing to deliver outsourced processing on time
- A regulatory fine for miscalculating capital ratios
Correct answer: A rogue trader concealing losses through unauthorized transactions
Internal fraud involves intentional acts by employees such as unauthorized trading, embezzlement, or falsifying records to conceal losses.
Question 3: Under the Basel II Basic Indicator Approach (BIA) for operational risk capital, the capital charge equals:
- 15% of the average positive annual gross income over the past three years (Correct answer)
- 12% of total risk-weighted assets across all business lines
- The 99.9% VaR of operational losses estimated from internal data
- 8% of total credit and market risk capital requirements
Correct answer: 15% of the average positive annual gross income over the past three years
The BIA applies a fixed alpha factor of 15% to average gross income as a simple proxy for operational risk exposure without differentiating by business line.
Question 4: What is the key advantage of the Advanced Measurement Approach (AMA) for operational risk capital over the Basic Indicator Approach?
- It allows banks to use internal loss data and models to calculate capital, potentially reducing the capital requirement (Correct answer)
- It eliminates the need to collect external operational loss data
- It requires less regulatory approval and oversight than simpler approaches
- It uses a fixed percentage of gross income, providing predictable capital charges
Correct answer: It allows banks to use internal loss data and models to calculate capital, potentially reducing the capital requirement
AMA permits sophisticated banks to build internal models incorporating loss history, scenarios, and risk factors, which can generate lower and more risk-sensitive capital requirements.
Question 5: What does 'Key Risk Indicator' (KRI) measure in an operational risk framework?
- A metric that signals changes in the level of operational risk exposure before losses materialize (Correct answer)
- The dollar amount of operational losses recorded in a given reporting period
- The capital buffer held against the highest-severity operational risk scenarios
- The frequency of audit findings related to operational control failures
Correct answer: A metric that signals changes in the level of operational risk exposure before losses materialize
KRIs are forward-looking metrics—such as system downtime, staff turnover, or failed trades—that provide early warning of increasing operational risk.
Question 6: Which of the following best describes 'scenario analysis' in operational risk management?
- A structured process where experts estimate the likelihood and impact of potential severe but plausible operational loss events (Correct answer)
- A backtesting exercise comparing modeled losses to historical loss data
- A real-time monitoring system that flags threshold breaches in KRIs
- A regulatory examination of a bank's internal controls and audit findings
Correct answer: A structured process where experts estimate the likelihood and impact of potential severe but plausible operational loss events
Scenario analysis uses expert judgment to assess low-frequency, high-severity events that may not appear in historical loss databases but could cause catastrophic losses.
