GARP FRM Part I Practice Test

Financial Risk Manager (FRM) Part I is the foundational GARP route for risk-management tools, quantitative analysis, financial markets and products, valuation, and risk models.

This page includes 12 original sample questions for initial review. They are not official GARP questions and do not reproduce a live exam; they are designed to preview the calculation, interpretation, and risk-concept judgment that a full Finance Prep route would need to support.

What this route should test

• quantitative methods, probability, statistics, and risk measurement concepts
• market instruments, derivatives, valuation, and model-risk basics
• foundations of risk management and how risk concepts connect across products
• calculation judgment without turning the page into a formula list

Sample Exam Questions

Use these questions to check whether your weaknesses are mostly quantitative mechanics, risk-measure interpretation, instrument recognition, or governance vocabulary before using the Notify me form for full FRM Part I coverage.

Question 1

Topic: value at risk interpretation

A trading desk reports a one-day 99% value at risk of $4 million. Which interpretation is most accurate?

• A. The desk cannot lose more than $4 million in one day
• B. Losses worse than $4 million are expected on about 1% of comparable trading days, assuming the model is valid
• C. The desk should earn $4 million on 99% of days
• D. The model measures the average loss after the $4 million threshold is breached

Best answer: B

Explanation: VaR is a quantile estimate, not a maximum-loss guarantee. A 99% one-day VaR of $4 million means the model expects losses to exceed $4 million on about 1% of comparable days. The average loss beyond the threshold is closer to expected shortfall, not VaR.

Question 2

Topic: duration and interest-rate risk

A fixed-rate bond has a longer duration than a comparable bond with the same credit quality. What should a risk analyst expect if market yields rise sharply?

• A. The longer-duration bond should be less sensitive because its maturity risk is spread over more periods
• B. Both bonds should change by the same amount because credit quality is identical
• C. The longer-duration bond should gain value because coupon payments become more valuable
• D. The longer-duration bond should generally fall more in price

Best answer: D

Explanation: Duration estimates price sensitivity to yield changes. When yields rise, fixed-rate bond prices generally fall, and the bond with higher duration is typically more sensitive. Same credit quality does not remove interest-rate sensitivity.

Question 3

Topic: diversification

Two risky assets have positive expected returns but imperfect correlation. Why might a portfolio of both assets have lower risk than either asset considered alone?

• A. Diversification can reduce unsystematic risk when returns do not move perfectly together
• B. Combining two risky assets always eliminates all market risk
• C. Correlation affects return but not risk
• D. The lower-risk asset automatically determines the portfolio risk

Best answer: A

Explanation: Imperfect correlation allows some asset-specific volatility to offset across holdings. Diversification does not eliminate systematic risk, and the portfolio risk depends on weights, volatilities, and correlations.

Question 4

Topic: distribution assumptions

A risk model assumes normally distributed daily returns, but the portfolio contains instruments with nonlinear payoffs and observed fat tails. What is the main concern?

• A. Normality will always overstate losses and make the model too conservative
• B. Nonlinear instruments remove the need for distribution assumptions
• C. Extreme losses may be underestimated if the model fails to capture tail behavior
• D. The model should ignore historical observations because they are backward-looking

Best answer: C

Explanation: Normal distributions can understate tail risk when returns have fat tails or payoffs are nonlinear. The issue is not that all models using normality are useless; it is that the analyst must understand when the assumption is too weak for the exposure.

Question 5

Topic: futures margin

A futures position is marked to market daily. A trader’s account balance increases after the settlement price moves in the trader’s favour. What does this most directly describe?

• A. Initial margin being returned permanently
• B. A credit-risk reserve being released
• C. Option premium being amortized
• D. Variation margin from daily settlement

Best answer: D

Explanation: Futures positions are settled daily through variation margin. Gains and losses are credited or debited as settlement prices change. Initial margin is the performance bond posted to support the position, not the daily profit-and-loss settlement itself.

Question 6

Topic: expected shortfall

Why might a risk committee prefer expected shortfall as a supplement to VaR?

• A. It ignores tail events so reports are easier to compare
• B. It estimates the average loss conditional on losses exceeding the chosen confidence threshold
• C. It always produces a lower number than VaR
• D. It removes model risk from the measurement process

Best answer: B

Explanation: Expected shortfall looks into the tail by estimating the average severity after the VaR threshold is breached. It still depends on models and assumptions, but it gives more information about extreme-loss severity than VaR alone.

Question 7

Topic: risk appetite

A firm wants to expand trading revenue but has not updated desk limits, escalation triggers, or stress-loss tolerances. What is the strongest governance concern?

• A. Risk appetite has not been translated into operating limits and controls
• B. Higher revenue targets automatically prove the risk appetite is too low
• C. Desk limits should be set only after losses occur
• D. Stress-loss tolerances are unnecessary if daily VaR is calculated

Best answer: A

Explanation: Risk appetite must connect strategy to measurable limits, escalation rules, and risk-taking permissions. VaR alone cannot substitute for governance, stress tolerances, and decision rights.

Question 8

Topic: option sensitivity

An option has a delta of 0.60. What does this measure most directly?

• A. The option’s sensitivity to changes in volatility
• B. The option’s sensitivity to the passage of time
• C. The approximate change in option value for a small change in the underlying price
• D. The probability that the counterparty will default

Best answer: C

Explanation: Delta is the first-order sensitivity of an option’s value to the underlying price. Vega measures sensitivity to volatility, theta to time decay, and counterparty default is a credit-risk issue.

Question 9

Topic: liquidity risk

A fund owns a security that is quoted daily, but only small quantities can be sold without a large price concession. Which risk is most directly highlighted?

• A. Translation risk
• B. Reinvestment risk
• C. Prepayment risk
• D. Market liquidity risk

Best answer: D

Explanation: Market liquidity risk is the risk that a position cannot be sold quickly at or near its quoted value. A daily quote is not enough if realistic sale size would move the price materially.

Question 10

Topic: VaR backtesting

A bank backtests a 99% one-day VaR model over 250 trading days. What is the best use of the exception count?

• A. Prove the model is perfect if there are no exceptions
• B. Compare actual exceedances with the number expected under the confidence level and investigate unusual results
• C. Replace stress testing because backtesting uses real outcomes
• D. Ignore exceptions caused by market stress because they are inconvenient for validation

Best answer: B

Explanation: Backtesting compares realized losses with model forecasts. A 99% one-day VaR would imply roughly 2 or 3 exceptions over 250 days, but interpretation should consider clustering, model assumptions, and market conditions. Backtesting complements stress testing; it does not replace it.

Question 11

Topic: model risk

A pricing model is mathematically elegant but uses stale inputs and assumptions that no longer match the traded product. What risk is most relevant?

• A. Model risk from incorrect assumptions, data, or implementation
• B. Settlement risk only
• C. Sovereign risk only
• D. The absence of any risk because the equations are advanced

Best answer: A

Explanation: Model risk can arise from flawed assumptions, stale data, poor implementation, or use outside the model’s intended scope. Technical sophistication does not remove the need for validation and fit-for-purpose review.

Question 12

Topic: counterparty exposure

Two counterparties have multiple offsetting trades under a legally enforceable netting agreement. What is the main risk-management effect?

• A. Gross exposure increases because more trades exist
• B. Market risk disappears because trades offset
• C. Counterparty credit exposure may be reduced because positive and negative values can be netted
• D. Operational risk becomes irrelevant

Best answer: C

Explanation: Netting can reduce counterparty credit exposure when agreements are legally enforceable. It does not eliminate market risk or operational risk, and it should not be assumed without legal and operational confirmation.

FRM Part I quick checklist

• Can you explain VaR, expected shortfall, stress testing, and backtesting without mixing them up?
• Can you connect duration, convexity, delta, and margin mechanics to the risk being measured?
• Can you identify when a clean formula answer is incomplete because model, data, or liquidity assumptions are weak?

Related GARP pages

• FRM Part II
• Sustainability and Climate Risk
• GARP certification updates