16 Sample FRM Mock Exams and Practice Questions with Solutions

When it comes to preparing for a competitive exam like Financial Risk Manager (FRM), practice is the key to crack it on your first attempt. The questions are structured in such a way it will put your understanding and application of the applicable concepts to the test. This ability can be developed by practising a variety of questions. However, FRM candidates frequently struggle to find FRM practise questions and sample tests. The following article will provide you with a glimpse of what FRM test questions are like:

Part I Sample Questions:

Q1. If the sample size is greater than 30 and population variance is unknown, the appropriate test for the sample mean is the:

1. z-test
2. p-test or F-test
3. t-test or z-test
4. t-test

The correct answer is: C

The central limit theorem makes it appropriate to use the z-test with an unknown variance if the sample size is large enough (n ≥ 30), regardless of the distribution of the population. Since the t- and the z-distributions converge as sample size increases, either test is appropriate, although the t-test is a more conservative estimate.

Q2. Given a three-factor arbitrage pricing theory (APT) model, what is the expected return on the Premium Dividend Yield Fund?

• The factor risk premiums to factors 1, 2 and 3 are 8%, 12% and 5%, respectively.
• The fund has sensitivities to the factors 1, 2, and 3 of 2.0, 1.0 and 1.0, respectively.
• The risk-free rate is 3.0%.

1. 36.0%
2. 50.0%
3. 28.0%
4. 33.0%

The correct answer is: A

The expected return on the Premium Dividend Yield Fund is 3% + (8.0%)(2.0) + (12.0%)(1.0) + (5.0%)(1.0) = 36.0%

Q3. The financial crisis stemmed from rising mortgage delinquencies and falling housing prices led to a worldwide liquidity crisis because institutions had:

1. held too much equity capital.
2. generated large maturity mismatches between assets and liabilities.
3. become less interconnected.
4. not taken enough leverage.

The correct answer is: B

The financial crisis that stemmed from rising mortgage delinquencies and falling housing prices led to a worldwide liquidity crisis because institutions had (1) taken on too much leverage, (2) generated large maturity mismatches between assets and liabilities, and (3) become too interconnected.

Q4. In commodity trading, the exchange removes any daily losses from a trader’s account and adds any gains to the trader’s account. This process is known as:

1. maintenance margin
2. variation margin
3. marking to market
4. initial margin

The correct answer is: C

To safeguard the clearinghouse, commodity exchanges require traders to settle their accounts on a daily basis. Marking to market is when any loss for the day is deducted from the trader’s account, and any gains are added to the account.

Q5. Prior to contract expiration the short in a futures contract can avoid futures exposure by:

1. using an exchange-for-physicals.
2. delivering the asset at the current spot price.
3. paying a cash settlement amount.
4. entering into a reversing trade.

The correct answer is: D

Prior to expiration, a futures position (long or short) is closed out by an offsetting/ reversing trade. The other methods are used to settle positions at contract expiration.

Q6. What is the term for the difference between the spot price and the future price, and what happens to it as the futures contract approaches expiration?

1. Basis; it decreases.
2. Spot different ; it approaches zero
3. Spot arbitrage; it increases.
4. Convergence; it decreases

The correct answer is: A

Basis = spot price − futures price

As maturity approaches, the basis converges to zero.

Q7. What is the yield to maturity (YTM) of a 20-year, U.S. zero-coupon bond selling for $300?

1. 3.06%
2. 6.11%
3. 7.20%
4. 5.90%

The correct answer is: B

N = 40; PV = 300; FV = 1,000; CPT → I = 3.055 × 2 = 6.11

Q8. Gamma-neutral hedging:

1. decreases sensitivity to small changes in asset prices.
2. increases sensitivity to large changes in asset prices.
3. increases sensitivity to small changes in asset prices.
4. decreases sensitivity to large changes in asset prices.

The correct answer is: D

Gamma-neutral hedging is designed to mitigate the effect of large changes in asset prices on delta-neutral positions that are designed to protect against small changes in asset prices.

Part II Sample Questions:

Q1. One of the easiest coherent risk measures is estimating expected shortfall (ES). What happens to the Expected Shortfall (ES) when the number of observations, n is increased?

1. The ES falls
2. The ES rises
3. The ES stays constant
4. The ES moves but not in a consistent manner

The correct answer is: B

When calculating the ES for varying values of n, the results reveal that the ES rises as n increases and gradually converges to the true value.

Q2. In an exam, Tom Lee was asked to give three core issues regarding risk measures commonly used in practice. Lee responded by saying that before embarking on risk measurement, one must decide on:

I. The risk measure to use
II. The weights to assign, and
III. The desired level of analysis

Which of the above-mentioned point(s) is/are correct regarding risk measures to use before embarking to measure risk?

1. Only Point I
2. Only Point II
3. Both I and II
4. Neither I nor II

The correct answer is: A

Before attempting to measure risks, one must establish the risk measure to use, e.g., the VaR, ES, etc. Next, a decision must be made whether to estimate the risk at the individual level or the portfolio level. In addition, one must select a suitable estimation method, such as parametric, non-parametric, or even Monte Carlo estimation.

Q3. A UK-based financial institution needs to consider the credibility of a Turkish-Greek bank. Analysts have already completed a substantial analysis of macro-level criteria that may directly influence the bank’s credit risk profile. Which of the following micro-level analyses must also be considered in analytical processes?

1. Comparing current results to historical performance as well as performance versus peers
2. The analysis of rating reports by major rating agencies
3. Assessing government issues and the likelihood of government intervention
4. The quality of regulation and the evaluation of credit review procedures

The correct answer is: A

To rank a bank’s comparative credit risk, the analyst needs to judge the credit risk of a particular institution at the micro level relative to its previous results (historical performance) and to similar entities (its peers).

Q4. Tom is a risk analyst at a large U.S. bank. While analysing credit risk for Trident Industries he extracts the following available information from the company’s financial statements:

Face value of debt: $120 Million,
Value of assets: $170 Million
He also estimates volatility of the company’s assets at 0.2
Given the above information, what’s Trident Industries’ distance to default for next year?

1. 1.74
2. 0.78
3. 4.37
4. 2.46

The correct answer is: A

Since we have limited data to evaluate DtD, we calculate DtD via the following approximation method:

DtD = (In V — In F)/σ

Where F = debt face value, σ = volatility, and V = asset value

DtD = (ln 170 – ln 120) / 0.2 = 1.74

Q5. Bank Lagum, based in Warsaw, Poland, approves a loan facility of $2 million as requested by Brezinsky Transports (BT) – one of its seasoned clients. The loan has a 5-year repayment plan. Two years after approval and disbursement, BT is declared bankrupt. To Bank Lagum, this effectively constitutes:

1. Foreign exchange risk
2. Reputational risk
3. Operational risk
4. Credit risk

The correct answer is: D

Credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments. The default of a client because of market conditions is still credit risk for the bank

Q6. Sarah Graham is a risk analyst at SimSam bank. She simulates the distribution of its operational losses and finds that the potential loss that corresponds to the 99 th percentile is $300,000 and the mean of the distribution is $60,000. An estimate of operational risk economic capital in this scenario is closest to:

1. $360,000
2. $240,000
3. $220,000
4. $300,000

The correct answer is: B

Operational risk economic capital is the difference between the loss at a given confidence level and the expected loss. In this case, $300,000 – $60,000 = $240,000.

Q7. The VaR of a portfolio will be maximised when the pairwise correlations between the returns of the underlying assets are:

1. Perfectly positive
2. Perfectly negative
3. Uncorrelated
4. Either positive or negative but not perfectly negative or positive

The correct answer is: A

When the returns of the assets in a portfolio are positively correlated, the portfolio is less diversified than when the returns are less correlated or negatively correlated. The extreme case situation occurs when the assets are perfectly positively correlated. In such a situation, the VaR of the portfolio will be at its highest.

Q8. Bank Aluvia has excess liquidity and it has decided to finance another bank under a repo agreement. Why would Aluvia Bank prefer a repo transaction to other market products such as the purchase of stocks?

1. A repo transaction would guarantee a quick return
2. A repo transaction would be faster and easier to execute
3. A repo transaction would be risk-free
4. A repo-transaction would be more secure

The correct answer is: D

Repo transactions are usually less risky because (I) they have short maturities and (II) the seller has to provide high-quality collateral.

These FRM sample questions will give you an idea and help you improve your exam-giving abilities. Try to practise as many questions as possible. After every incorrect answer, revising that topic again is important for preparing yourself for the exam. Learn to solve the questions patiently and not get discouraged if you get any of them wrong.

Goodluck!

If you have decided to pursue FRM, The Wall Street School can help you take a step forward. Check out our FRM course to learn more. Good Luck and Happy Career Building in the world of Finance and Accounting!