FRM Review and Assessment 3

Question 1

When assessing credit risk, what does Expected Loss (EL) equal?

Accepted Answer

PD × LGD × EAD

Answer

Expected Loss is the product of Probability of Default, Loss Given Default, and Exposure at Default.

Question 2

A review of a duration-based hedge finds it fails for large rate moves. What property explains this?

Accepted Answer

Convexity, the curvature of the price-yield relationship

Answer

Duration is a linear approximation; convexity captures the curvature that matters for large yield changes.

Question 3

In assessing liquidity risk, the Liquidity Coverage Ratio (LCR) ensures a bank can survive how long under stress?

Accepted Answer

30 days

Answer

The LCR requires enough high-quality liquid assets to cover net cash outflows over a 30-day stress period.

Question 4

A risk committee reviews a trade with high gamma. What does high gamma imply about hedging?

Accepted Answer

The delta hedge needs frequent rebalancing

Answer

High gamma means delta changes rapidly with the underlying, requiring frequent rebalancing of the hedge.

Question 5

An assessment of correlation assumptions during a crisis should account for which phenomenon?

Accepted Answer

Correlations often rise toward 1 in crises (correlation breakdown)

Answer

In stress periods, asset correlations frequently spike, reducing diversification benefits when they are needed most.

FRM Practice Test