📘 FRR-Sample Paper 1

📘 FRR-Sample Paper 1

 

Q1.
A bank grants a loan of USD 80 million with a probability of default (PD) = 2%, loss given default (LGD) = 50%, and exposure at default (EAD) = 100%. What is the expected loss?
A. USD 0.5 million
B. USD 0.8 million
C. USD 1.0 million
D. USD 1.2 million

Q2.
Which Basel II approach for credit risk typically produces the lowest capital requirement, provided sufficient data and supervisory approval?
A. Standardized Approach
B. Foundation IRB
C. Advanced IRB
D. Basic Indicator Approach

Q3.
Which of the following credit risk models is primarily based on ratings migration data?
A. CreditMetrics
B. CreditRisk+
C. CreditPortfolioView
D. Merton Model

Q4.
A loan of USD 100,000 is collateralized by securities worth USD 30,000. The LGD is 40%. What is the exposure at default (EAD)?
A. USD 40,000
B. USD 60,000
C. USD 70,000
D. USD 100,000

Q5.
Two loans each have a PD of 5%. If modeled as independent, what is the probability both default together?
A. 0.25%
B. 0.50%
C. 1.0%
D. 5.0%

Q6.
Stress testing of credit portfolios is primarily used to:
A. Maximize yield spreads on loans
B. Identify vulnerabilities under extreme but plausible scenarios
C. Replace internal ratings with external ratings
D. Eliminate the need for expected loss calculations

Q7.
Which metric represents the average portfolio credit loss and is used for pricing credit instruments?
A. Credit VaR
B. Unexpected Loss
C. Expected Loss
D. Recovery Rate

Q8.
Under Basel II standardized rules, a non-performing corporate loan overdue more than 90 days with no provisions must be risk-weighted at:
A. 100%
B. 125%
C. 150%
D. 200%

Q9.
Which category of risk weights was introduced under Basel III to increase sensitivity to credit quality?
A. Country-specific capital floors
B. External ratings migration matrices
C. Granular corporate risk weights
D. Securitization tranches

Q10.
Which of the following best defines Probability of Default (PD)?
A. Chance that the borrower fails to repay in full and on time
B. Portion of the exposure that cannot be recovered after default
C. Total amount owed at the time of default
D. Loss amount after recovery

Q11.
How does a higher LGD impact a bank’s capital requirement?
A. Decreases capital since less recovery is assumed
B. Increases capital since potential losses rise
C. Has no effect on capital calculations
D. Lowers RWA but raises unexpected loss

Q12.
A bank prices a loan with credit spread of 150 bps over risk-free rate. Which risk is the spread compensating for primarily?
A. Liquidity risk
B. Credit risk
C. Market risk
D. Operational risk

Q13.
What is the main benefit to a bank of compensating balances?
A. Provides collateral substitute and reduces exposure
B. Increases loan size and spreads
C. Decreases expected loss by lowering PD
D. Improves borrower’s liquidity position

Q14.
In a syndicated loan, the main credit risk to participating banks is:
A. Sovereign downgrade risk
B. Concentration risk if borrowers are correlated
C. Settlement risk on daily transactions
D. Operational risk in documentation

Q15.
Which type of credit risk is most relevant for a government bond issuance?
A. Counterparty credit risk
B. Sovereign credit risk
C. SME credit risk
D. Retail credit risk

Q16.
Which is a key difference between internal ratings and external ratings?
A. External ratings are more forward-looking
B. Internal ratings are always less granular
C. Internal ratings reflect a bank’s own risk appetite
D. External ratings are free from conflict of interest

Q17.
Correlation between obligors in a portfolio primarily affects which risk measure?
A. Probability of Default
B. Recovery Rate
C. Unexpected Loss
D. Maturity adjustment

Q18.
Expected loss is designed to be covered through:
A. Regulatory capital
B. Loan pricing and provisioning
C. Insurance contracts
D. Diversification

Q19.
Diversification benefits in a credit portfolio are limited when:
A. Loans are to uncorrelated borrowers
B. All exposures are sovereign-guaranteed
C. Borrowers are exposed to the same macroeconomic shocks
D. Collateral values are volatile but unrelated

Q20.
Unexpected Loss in credit risk primarily determines:
A. Loan pricing margin
B. Economic capital needs
C. Accounting reserves
D. Net interest margin

 

Q21.
A bank is long GBP 400 million, short GBP 100 million in delta-equivalent options, and long GBP 50 million in equities. What is the net GBP exposure?
A. GBP 250 million
B. GBP 300 million
C. GBP 350 million
D. GBP 400 million

Q22.
Which of the following is a limitation of Value-at-Risk (VaR)?
A. Cannot capture tail risk beyond confidence level
B. Always overestimates losses
C. Ignores correlation across assets
D. Requires no backtesting

Q23.
Which option Greek measures the rate of change of delta with respect to the underlying asset price?
A. Vega
B. Theta
C. Gamma
D. Rho

Q24.
Which Greek captures the sensitivity of an option’s value to volatility?
A. Vega
B. Delta
C. Gamma
D. Theta

Q25.
The value of a plain vanilla swap is best approximated by:
A. Difference in value between fixed and floating bonds
B. Notional × maturity
C. Spread × notional × time
D. Present value of coupon payments

Q26.
A futures contract requires 5% margin. If notional is USD 20 million, how much margin must be posted?
A. USD 0.5 million
B. USD 1.0 million
C. USD 1.5 million
D. USD 2.0 million

Q27.
Correlation price risk is most relevant in which portfolio?
A. Single bond positions
B. Equity index arbitrage positions
C. Retail loan book
D. Commodity spot holdings

Q28.
In VaR modeling, position mapping is used to:
A. Group similar exposures into risk buckets
B. Increase number of risk factors
C. Remove diversification benefits
D. Avoid portfolio-level calculations

Q29.
Stress testing is superior to VaR because it:
A. Captures extreme scenarios outside historical data
B. Eliminates need for regulatory capital
C. Always reduces measured risk
D. Replaces internal audit

Q30.
A trading desk reports a daily P&L of -USD 1 million, while the 1-day 99% VaR was estimated at USD 0.8 million. Which conclusion is correct?
A. Model underestimates risk
B. Model overestimates risk
C. No backtesting issue
D. Diversification reduced P&L losses

Q31.
VaR is not a coherent risk measure because it violates which property?
A. Subadditivity
B. Monotonicity
C. Homogeneity
D. Translation invariance

Q32.
Backtesting of VaR primarily compares:
A. Predicted VaR with actual trading losses
B. Regulatory capital with economic capital
C. Expected loss with unexpected loss
D. Market prices with book values

Q33.
Which is the primary risk with rogue trading incidents?
A. Regulatory penalties
B. Under-reporting and concentration of positions
C. Yield curve shifts
D. Credit spreads widening

Q34.
If a trade expects USD 5 million profit, and VaR is USD 10 million, what is the RAROC?
A. 5%
B. 10%
C. 50%
D. 100%

Q35.
Volatility clustering refers to:
A. Volatility remaining constant over time
B. High-volatility periods being followed by high-volatility
C. Diversification eliminating volatility
D. Volatility being independent of past

Q36.
Economic capital differs from regulatory capital because it is:
A. Based on regulatory formulas
B. Determined by supervisors
C. Bank’s internal estimate of risks
D. Equivalent to Tier 1 capital

Q37.
Credit spread risk is most closely associated with which market risk type?
A. Interest rate risk
B. FX risk
C. Equity risk
D. Liquidity risk

Q38.
Duration and convexity in bonds are conceptually similar to which Greeks in options?
A. Delta and Gamma
B. Delta and Vega
C. Theta and Rho
D. Vega and Gamma

Q39.
To hedge a positive duration gap, a bank may:
A. Enter into receive-fixed, pay-floating swaps
B. Enter into pay-fixed, receive-floating swaps
C. Buy long-dated sovereign bonds
D. Reduce non-interest income

Q40.
Which is an example of a yield curve stress scenario?
A. Parallel upward shift
B. Credit spread widening
C. Volatility clustering
D. Liquidity freeze

Q41.

Under Basel II, what is the common minimum threshold for reporting an operational risk event?

A. EUR 1,000

B. EUR 10,000

C. EUR 100,000

D. EUR 1,000,000

 

Q42.

Which Basel approach uses a single indicator (gross income) to calculate operational risk capital?

A. Standardized Approach

B. Advanced Measurement Approach (AMA)

C. Basic Indicator Approach

D. Simplified Standardized Approach

 

Q43.

Which of the following is an example of internal fraud?

A. Theft of customer funds by staff

B. Credit card fraud by external parties

C. System outage due to software bug

D. Lawsuit for wrongful termination

 

Q44.

An employee wins a legal case against a bank for gender discrimination. This event falls under which Basel category?

A. Execution, Delivery & Process Management

B. Clients, Products & Business Practices

C. Employment Practices & Workplace Safety

D. Business Disruption & System Failures

 

Q45.

If participants in a scenario analysis inflate estimates to protect their department’s reputation, this is an example of:

A. Anchoring bias

B. Availability bias

C. Motivational bias

D. Selection bias

 

 

Q46.

In industry loss databases, “external fraud” events often dominate due to:

A. Under-reporting of internal fraud

B. Large participation by retail banks

C. Overestimation of model bias

D. Supervisory thresholds being too low

 

Q47.

Under AMA, banks must collect which operational loss data?

A. Only recoveries and net loss

B. Gross loss, event date, and thresholds

C. Staff errors only

D. Litigation losses only

 

Q48.

What is the primary purpose of Risk & Control Self-Assessments (RCSA)?

A. Estimate expected credit losses

B. Identify, assess, and monitor operational risks

C. Calculate regulatory capital

D. Replace internal audit

 

Q49.

“Red light” reporting focuses on:

A. All minor exceptions

B. Only highest-priority issues

C. Detailed daily updates

D. Threshold breaches below limits

 

 

 

 

Q50.

A power outage that shuts down branch operations for two days is classified as:

A. Employment Practices loss

B. Execution & Delivery loss

C. Business Disruption and System Failures

D. Clients, Products & Business Practices

 

Q51.

Unexpected losses in operational risk usually arise from:

A. Low-frequency, high-impact events

B. High-frequency, low-impact events

C. Low-frequency, low-impact events

D. High-frequency, high-impact events

 

Q52.

Which Basel II event category includes errors in settlement or documentation?

A. Employment Practices & Workplace Safety

B. Execution, Delivery & Process Management

C. Business Disruption & System Failures

D. External Fraud

 

Q53.

Operational risk stress testing is used mainly to:

A. Project expected loss provisions

B. Assess resilience to extreme scenarios

C. Replace VaR analysis

D. Eliminate the need for RCSA

 

 

 

 

Q54.

In the three lines of defense model, Internal Audit is considered the:

A. First line

B. Second line

C. Third line

D. Fourth line

 

Q55.

Which is a valid use of scenario analysis in operational risk?

A. Identifying potential mitigation actions

B. Eliminating motivational bias

C. Avoiding Basel compliance

D. Setting compensation targets

 

Q56.

In loss data consortia (e.g., ORX), which type of event is most frequent in retail banks?

A. External fraud

B. Legal risk

C. Employment practices disputes

D. IT system outages

 

Q57.

Continuous monitoring and reporting of operational risks primarily ensures:

A. Profits are maximized

B. Risks are identified early and addressed

C. Supervisors set thresholds

D. Economic capital is reduced

 

 

 

Q58.
Which of the following is a key requirement under Basel guidelines for effective operational risk governance?
A. The Board and senior management must establish a strong risk culture and clear accountability.
B. Supervisors must approve every individual operational loss event.
C. Banks must outsource all risk control functions to third parties.
D. Internal audit must calculate regulatory capital for operational risk.

Q59.

A lawsuit against a bank for misleading financial advice would be categorized as:

A. Clients, Products & Business Practices risk

B. Execution & Delivery risk

C. Employment Practices risk

D. Business Disruption risk

Q60.

If analysts anchor to an initial loss estimate and ignore new information, this is:

A. Anchoring bias

B. Motivational bias

C. Availability bias

D. Selection bias

Q61.
If 3-month Treasury yield is 0.7% and 3-month LIBOR is 2.3%, what is the TED spread?
A. 1.4%
B. 1.6%
C. 1.8%
D. 2.0%

Q62.
For the Liquidity Coverage Ratio (LCR), banks must assume 30-day outflows from:
A. 100% of wholesale funding with no operational relationship
B. 0% of stable deposits
C. 25% of all deposits
D. No committed facilities

Q63.
Which best describes the Net Stable Funding Ratio (NSFR)?
A. Liquidity over a 5-day horizon
B. Available stable funding relative to required stable funding over 1 year
C. Ratio of HQLA to net outflows
D. Leverage ratio alternative

 

Q64.
Funds Transfer Pricing (FTP) helps ALM by:
A. Allocating costs of funds across business lines
B. Minimizing operational losses
C. Calculating credit VaR
D. Setting regulatory buffers

Q65.
A bank funds a 10-year fixed loan with 6-month deposits. The bank is:
A. Asset sensitive
B. Liability sensitive
C. Market neutral
D. Hedge insensitive

Q66.
The purpose of hedging Economic Value of Equity (EVE) is to:
A. Immunize against changes in interest rates
B. Maximize trading income
C. Reduce accounting earnings volatility
D. Replace regulatory capital

Q67.
If a bank has a positive duration gap and rates rise, what happens to EVE?
A. Increases
B. Decreases
C. Unchanged
D. First increases then decreases

Q68.
The fully-implemented Basel III Capital Conservation Buffer is:
A. 0%
B. 1.5%
C. 2.5%
D. 3.5%

Q69.
Which is a prescribed ICAAP yield curve scenario?
A. Parallel shift
B. Commodity price shock
C. Sovereign downgrade
D. Equity volatility spike

Q70.
Under Basel II, the minimum total capital adequacy ratio (CAR) is:
A. 4% of RWA
B. 6% of RWA
C. 8% of RWA
D. 10% of RWA

 

Q71.
Which of the following constitutes Tier 2 capital?
A. Retained earnings
B. Paid-up common equity
C. Subordinated debt
D. Tangible common equity

Q72.
Profits retained by a bank to strengthen its capital base are called:
A. Retentions
B. Reinvestments
C. Regulatory earnings
D. Reserves

Q73.
Economic capital differs from regulatory capital because:
A. It is imposed by supervisors
B. It covers only operational risks
C. It is an internal estimate based on the bank’s risk profile
D. It equals Tier 1 + Tier 2 capital

Q74.
Dodd-Frank stress tests (DFAST) require reporting of which capital measure?
A. CET1 ratio
B. Market leverage ratio
C. Price-to-book ratio
D. Net profit margin

Q75.
Deterioration in government finances and external debt levels are indicators of:
A. Corporate credit risk
B. Sovereign credit risk
C. Operational risk
D. Market liquidity risk

Q76.
Liquidity contingency planning typically includes:
A. Hedging correlation risk
B. Pre-arranged credit lines and asset sales
C. Raising operational risk capital
D. Lowering CET1 ratio

Q77.
A bank sells sovereign bonds under repurchase agreements primarily to:
A. Increase equity capital
B. Hedge interest rate risk
C. Obtain short-term liquidity
D. Reduce credit exposures

 

Q78.
A bank’s balance sheet shows risk-weighted assets of USD 200 million. What is the minimum Basel II capital requirement (8%)?
A. USD 12 million
B. USD 14 million
C. USD 15 million
D. USD 16 million

Q79.
The Basel III leverage ratio is defined as:
A. Tier 1 capital / total exposures
B. CET1 capital / RWA
C. Tier 2 capital / RWA
D. Equity capital / tangible assets

Q80.
Counterparty credit risk in swaps can be reduced by:
A. Trading through a central clearing house
B. Increasing notional size
C. Extending maturities
D. Ignoring collateral

 

📘FRR-Sample Paper 1 (Answers & Explanations)

 

 

Q1. B – EL = PD × LGD × EAD = 2% × 50% × 100% × 80m = 0.8m
Q2. C – Advanced IRB uses granular inputs, typically lowest capital.
Q3. A – CreditMetrics is based on migration matrices.
Q4. D. EAD is the total outstanding exposure at default; collateral and LGD affect loss, not EAD.
Q5. A– Joint probability = 5% × 5% = 0.25%, A (0.25%).
Q6. B – Stress testing identifies vulnerabilities under extreme scenarios.
Q7. C – Expected Loss is average loss measure.
Q8. C – Basel II: 150% risk weight for >90-day overdue, no provisions.
Q9. D – Basel III risk weights enhanced for securitization tranches.
Q10. A – PD = chance of default.
Q11. B – Higher LGD → higher capital.
Q12. B – Credit spread compensates credit risk.
Q13. A – Compensating balances offset exposure.
Q14. B – Syndicated loans → concentration if correlated borrowers.
Q15. B – Sovereign risk for government bonds.
Q16. C – Internal ratings reflect bank’s risk appetite.
Q17. C – Correlation raises Unexpected Loss.
Q18. B – EL covered by provisioning & pricing.
Q19. C – Correlated borrowers reduce diversification.
Q20. B – UL drives economic capital.

Q21. C – Net = 400 – 100 + 50 = 350m.
Q22. A – VaR ignores tail risk beyond CL.
Q23. C – Gamma = rate of change of Delta.
Q24. A – Vega = sensitivity to volatility.
Q25. A – Swap value = diff of fixed vs floating bond values.
Q26. B – Margin = 20m × 5% = 1m.
Q27. B – Correlation risk most relevant in index arbitrage.
Q28. A – Position mapping groups exposures.
Q29. A – Stress testing covers extreme events.
Q30. A – Actual loss > VaR → model underestimates risk.
Q31. A – VaR violates subadditivity.
Q32. A – Backtesting = predicted vs actual losses.
Q33. B – Rogue traders → under-report & concentration.
Q34. C – RAROC = 5 ÷ 10 = 50%.
Q35. B – Volatility clustering = persistence of high/low vol.
Q36. C – Economic capital = bank’s internal estimate.
Q37. A – Credit spreads → interest rate risk component.
Q38. A – Duration/convexity ≈ Delta/Gamma.
Q39. B – Pay-fixed/receive-float hedges positive duration gap.
Q40. A – Stress = parallel upward shift.

Q41. B – Basel II threshold commonly EUR 10k.
Q42. C – BIA uses gross income.
Q43. A – Internal fraud = staff theft.
Q44. C – Discrimination → Employment Practices.
Q45. C – Motivational bias = gaming system.
Q46. B – Retail banks drive external fraud dominance.
Q47. B – AMA requires gross loss, date, thresholds.
Q48. B – RCSA identifies & monitors risks.
Q49. B – “Red light” = only high-priority issues.
Q50. C – Power outage = Business Disruption.
Q51. A – Unexpected = low-frequency, high-impact.
Q52. B – Errors → Execution & Delivery.
Q53. B – Stress test = resilience to extremes.
Q54. C – Internal Audit = 3rd line of defense.
Q55. A – Scenario analysis → mitigation actions.
Q56. A – External fraud dominates in retail banks.
Q57. B – Monitoring ensures early identification.
Q58. A – Basel principles stress that a sound risk culture, set by the Board and senior management.
Q59. A – Misleading advice → Clients, Products & Practices.
Q60. A – Anchoring bias = sticking to initial estimate.

Q61. B – TED = 2.3 – 0.7 = 1.6%.
Q62. A – LCR: 100% outflow for wholesale without operational relation.
Q63. B – NSFR = ASF ÷ RSF over 1 year.
Q64. A – FTP allocates funding costs.
Q65. B – Fixed long loan, short deposits → liability sensitive.
Q66. A – Hedging EVE immunizes against rates.
Q67. B – Positive duration gap, rates ↑ → EVE ↓.
Q68. C – CCB = 2.5%.
Q69. A – ICAAP requires parallel shifts & curve shocks.
Q70. C – Basel II CAR = 8% RWA.
Q71. C – Subordinated debt = Tier 2.
Q72. A – Retained profits = retentions.
Q73. C – Economic capital = internal estimate.
Q74. A – DFAST uses CET1, leverage, etc.
Q75. B – Indicators = sovereign risk.
Q76. B – Contingency planning → credit lines & asset sales.
Q77. C – Repo provides short-term liquidity.
Q78. D – 200m × 8% = 16m.
Q79. A – Leverage ratio = Tier 1 ÷ exposures.
Q80. A – Clearing house reduces counterparty risk.