FRM FRM 2 — Questions and Answers
Question 1: A portfolio has a one-day 99% VaR of $1 million. What does this figure most accurately represent?
- The maximum possible loss over one day
- The loss that will be exceeded on 1% of days (Correct answer)
- The average loss on the worst days
- The guaranteed loss every day
Correct answer: The loss that will be exceeded on 1% of days
A 99% one-day VaR of $1M means losses should exceed $1M on only 1% of trading days.
Question 2: Which risk measure, unlike VaR, satisfies the coherence property of subadditivity in all cases?
- Standard deviation
- Expected Shortfall (CVaR) (Correct answer)
- Maximum drawdown
- Notional exposure
Correct answer: Expected Shortfall (CVaR)
Expected Shortfall is a coherent risk measure that always satisfies subadditivity, whereas VaR may not.
Question 3: Under the Basel framework, which type of risk capital charge specifically addresses losses from inadequate internal processes, people, and systems?
- Market risk capital
- Credit risk capital
- Operational risk capital (Correct answer)
- Liquidity coverage ratio
Correct answer: Operational risk capital
Operational risk capital covers losses from failed internal processes, people, systems, or external events.
Question 4: A bond's duration is 6 and its convexity is 80. For a 1% (0.01) rise in yields, the convexity adjustment to the price change is approximately:
- +0.40% (Correct answer)
- -0.40%
- +6.00%
- -6.00%
Correct answer: +0.40%
The convexity adjustment is 0.5 × convexity × (Δy)² = 0.5 × 80 × 0.0001 = +0.40%.
Question 5: Which Greek measures the rate of change of an option's delta with respect to the underlying price?
- Theta
- Vega
- Gamma (Correct answer)
- Rho
Correct answer: Gamma
Gamma measures how quickly delta changes as the underlying asset price moves.
Question 6: In credit risk, the expected loss on an exposure is calculated as:
- PD × LGD × EAD (Correct answer)
- PD + LGD + EAD
- PD × EAD / LGD
- LGD × maturity
Correct answer: PD × LGD × EAD
Expected Loss equals Probability of Default times Loss Given Default times Exposure at Default.
Question 7: Which type of backtesting exception would most concern a risk manager validating a VaR model?
- Realized losses never exceed VaR
- Exceptions occur far more frequently than the confidence level implies (Correct answer)
- VaR equals zero on weekends
- Profits exceed VaR
Correct answer: Exceptions occur far more frequently than the confidence level implies
Too many exceptions relative to the model's confidence level signals the VaR model underestimates risk.
FRM FRM 2
A portfolio has a one-day 99% VaR of $1 million.
What does this figure most accurately represent?