📘 FRR-Sample Paper 2

 

📘 FRR-Sample Paper 2

 

Q1.
A bank extends a USD 120 million loan. PD = 3%, LGD = 45%, EAD = 100%. What is the expected loss?
A. USD 1.35 million
B. USD 1.62 million
C. USD 2.00 million
D. USD 5.40 million

Q2.
Which Basel credit risk approach allows banks to estimate both PD and LGD internally, subject to supervisory approval?
A. Standardized Approach
B. Foundation IRB
C. Advanced IRB
D. Simplified Standardized

Q3.
Which model uses a structural approach where default occurs if firm asset value < debt level?
A. CreditMetrics
B. CreditRisk+
C. Merton Model
D. CreditPortfolioView

Q4.
A USD 500,000 loan has USD 200,000 collateral. PD = 4%, LGD = 40%. What is expected loss?
A. USD 8,000
B. USD 12,000
C. USD 20,000
D. USD 80,000

Q5.
Two loans each have PD = 8%. If independent, what is probability both default?
A. 0.32%
B. 0.64%
C. 1.00%
D. 8.00%

Q6.
Which of the following is most likely captured by credit concentration risk?
A. Multiple loans to same corporate group
B. Higher volatility of interest rates
C. Losses due to rogue trading
D. Decline in collateral market value

 

 

Q7.
Expected Loss is priced into lending spread. Unexpected Loss is typically covered by:
A. Loan pricing margin
B. Provisions
C. Economic capital
D. Depositor protection

Q8.
A corporate bond is downgraded from A to BBB. Which capital treatment is impacted most?
A. Liquidity coverage
B. Operational risk buffer
C. Risk-weighted assets
D. Tier 2 capital eligibility

Q9.
A 10-year loan has PD = 2%, LGD = 50%, EAD = 1,000,000. Assuming independence each year, approximate 10-year cumulative PD ≈ ?
A. 10%
B. 18%
C. 25%
D. 50%

Q10.
Which best explains Wrong-Way Risk in credit exposures?
A. PD decreases as exposure increases
B. PD increases as exposure increases
C. PD and exposure are independent
D. LGD falls when collateral rises

Q11.
Collateral reduces:
A. EAD
B. PD
C. LGD
D. Maturity adjustment

Q12.
Which statement about securitization tranches is most correct?
A. Senior tranches carry highest capital charges
B. Equity tranches absorb first losses
C. Mezzanine tranches have zero LGD
D. Risk weights are identical across tranches

Q13.
Which risk type is most difficult to diversify in a credit portfolio?
A. Idiosyncratic risk
B. Systematic risk
C. Counterparty risk
D. Collateral risk

Q14.
A retail loan portfolio has average PD = 3%. If downturn PD rises to 5%, what principle is being tested?
A. Through-the-cycle rating
B. Point-in-time rating
C. Stress testing
D. Credit migration

Q15.
Which is most relevant for Sovereign Credit Risk assessment?
A. Debt-to-GDP ratio trends
B. Operational loss databases
C. Trader fraud history
D. Repo market liquidity

Q16.
Which Basel rule increases capital when exposures are highly correlated?
A. Pillar 1 standard formulas
B. Pillar 2 ICAAP requirements
C. Pillar 3 disclosure
D. Operational loss thresholds

Q17.
If a loan has EAD = 100m, PD = 1%, LGD = 70%, what is Expected Loss?
A. 0.5m
B. 0.7m
C. 1.0m
D. 1.5m

Q18.
Which portfolio is least likely to benefit from diversification?
A. Loans across sectors in one economy
B. Loans across uncorrelated sovereigns
C. Loans across retail, SME, and corporate
D. Loans across geographies with low correlation

Q19.
Unexpected Loss can be reduced primarily by:
A. Setting higher spreads
B. Provisioning more reserves
C. Portfolio diversification
D. Shortening loan maturities

Q20.
Which credit risk model is based on Poisson default assumptions?
A. CreditMetrics
B. CreditRisk+
C. Merton Model
D. Moody’s KMV

Q21.
A bank is long USD 300m spot, short USD 150m delta-equivalent options, and long USD 100m in equities. What is net exposure?
A. USD 150m
B. USD 200m
C. USD 250m
D. USD 300m

Q22.
Which is a key limitation of VaR under crisis conditions?
A. Ignores correlations
B. Ignores extreme tail risk
C. Always overstates losses
D. Requires no historical data

Q23.
Which Greek measures option value sensitivity to time decay?
A. Delta
B. Vega
C. Theta
D. Gamma

Q24.
A trader holds a portfolio of basket options. The most relevant risk is:
A. Vega
B. Rho
C. Correlation risk
D. Theta

Q25.
At inception, the value of an interest rate swap is:
A. Positive
B. Negative
C. Zero
D. Equal to the notional

Q26.
A futures contract has notional = 50m, margin requirement = 2%. How much margin is posted?
A. 0.5m
B. 1.0m
C. 1.5m
D. 2.0m

Q27.
Which risk is most relevant when long one equity index future and short another index future?
A. Interest rate risk
B. Correlation risk
C. Counterparty risk
D. FX risk

Q28.
VaR mapping is used primarily to:
A. Aggregate exposures into factor buckets
B. Eliminate backtesting
C. Inflate risk estimates
D. Reduce RWA directly

Q29.
Why is stress testing essential alongside VaR?
A. Captures extreme but plausible events
B. Eliminates need for regulatory capital
C. Guarantees model approval
D. Provides daily P&L attribution

Q30.
If 1-day 99% VaR = 15m, but actual daily loss = 20m, this indicates:
A. Model underestimates tail risk
B. Model overestimates risk
C. Diversification benefit captured
D. No issue since VaR is exceeded rarely

Q31.
VaR fails to satisfy which coherence property?
A. Homogeneity
B. Subadditivity
C. Monotonicity
D. Translation invariance

Q32.
Backtesting failures indicate:
A. VaR model not calibrated correctly
B. RWA understated
C. Expected loss miscalculated
D. Collateral misreported

Q33.
Which best describes risk from rogue trading?
A. Overstated reserves
B. Concealed losses and concentration
C. Interest rate risk mispricing
D. External fraud

Q34.
A desk expects USD 6m profit. VaR = USD 12m. What is RAROC?
A. 25%
B. 50%
C. 75%
D. 100%

 

Q35.
Which describes volatility clustering?
A. High-volatility periods followed by high volatility
B. Independent volatility observations
C. Volatility disappears over time
D. Long-run volatility always constant

Q36.
Economic capital is best described as:
A. Minimum capital required by regulators
B. Internal capital to cover unexpected losses
C. Accounting reserves for EL
D. Tier 1 + Tier 2 capital

Q37.
Credit spread risk falls under:
A. Market risk
B. Operational risk
C. Liquidity risk
D. Reputation risk

Q38.
Duration & convexity correspond most closely to which Greeks?
A. Delta & Gamma
B. Delta & Vega
C. Theta & Rho
D. Vega & Gamma

Q39.
To hedge a liability-sensitive balance sheet, a bank should:
A. Pay fixed, receive floating swaps
B. Receive fixed, pay floating swaps
C. Buy short-term deposits
D. Sell sovereign bonds

Q40.
Which stress scenario steepens the yield curve?
A. Short rates down, long rates up
B. Short rates up, long rates down
C. Parallel upward shift
D. Sovereign downgrade

Q41.
Under the Basic Indicator Approach, operational risk capital is calculated as:
A. Fixed % of gross income
B. Fixed % of total assets
C. Weighted average of PD × LGD × EAD
D. Supervisory-set capital floor

 

Q42.
Which Basel II category includes “losses from mis-selling products to clients”?
A. Employment Practices & Workplace Safety
B. Clients, Products & Business Practices
C. External Fraud
D. Execution & Delivery

Q43.
A bank experiences trading losses because staff ignored risk limits. This event is classified as:
A. Internal Fraud
B. External Fraud
C. Execution & Delivery failure
D. Business Disruption

Q44.
Which operational risk event is most difficult to model using historical data?
A. Frequent transaction errors
B. Low-frequency cyberattacks
C. Small recurring card frauds
D. Staff absenteeism

Q45.
Which is the primary reason regulators encourage banks to participate in loss data consortia (e.g., ORX)?
A. Reduce expected loss estimates
B. Provide external data for low-frequency events
C. Eliminate motivational bias
D. Lower capital requirements directly

Q46.
A pandemic forcing remote work is most likely categorized as:
A. Employment Practices risk
B. Business Disruption & System Failures
C. Internal Fraud
D. Clients, Products & Business Practices

Q47.
Motivational bias in scenario analysis occurs when:
A. Initial estimates anchor judgments
B. Participants favor outcomes that benefit their unit
C. Recent events dominate judgments
D. Supervisors provide fixed assumptions

Q48.
What is the third line of defense in operational risk frameworks?
A. Risk management function
B. Compliance function
C. Internal Audit
D. Front-line business managers

Q49.
Which Basel principle highlights that the Board must set the tone for operational risk governance?
A. Strong risk culture and accountability
B. Detailed reporting frequency
C. External audit certification
D. Capital conservation

Q50.
A cyberattack shuts down online banking for 48 hours. Which category applies?
A. External Fraud
B. Business Disruption & System Failures
C. Employment Practices
D. Clients & Business Practices

Q51.
Which is the best example of unexpected loss in operational risk?
A. Small payment errors repeated daily
B. Large fraud discovered after several years
C. Provisioning shortfall
D. Regular staff training costs

Q52.
Which Basel II event category includes failed trade settlements?
A. Execution, Delivery & Process Management
B. External Fraud
C. Business Disruption
D. Legal Risk

Q53.
Why do banks maintain key risk indicators (KRIs)?
A. Provide early warning signals of potential losses
B. Replace regulatory capital models
C. Quantify Expected Loss directly
D. Reduce Tier 1 capital requirements

Q54.
In AMA, four data elements are required: internal data, external data, scenario analysis, and:
A. Stress testing
B. Key risk indicators
C. Business environment & internal control factors
D. Backtesting

Q55.
Which risk is most often underestimated in outsourcing arrangements?
A. Reputational risk
B. Counterparty credit risk
C. Market risk
D. Liquidity risk

 

Q56.
Which reporting approach highlights only the most severe operational risk issues?
A. Green light reporting
B. Yellow light reporting
C. Red light reporting
D. Blue light reporting

Q57.
Which Basel component is most concerned with public disclosure of operational risk frameworks?
A. Pillar 1
B. Pillar 2
C. Pillar 3
D. Supervisory review

Q58.
If a bank misrepresents terms of a structured product to clients, this falls under:
A. Employment Practices
B. Clients, Products & Business Practices
C. Execution & Delivery
D. External Fraud

Q59.
Which factor most directly increases operational risk capital under the Standardized Approach?
A. Higher gross income in business lines
B. Higher CET1 ratio
C. Higher Expected Loss provisioning
D. Lower duration gap

Q60.
An operational risk framework is most effective when:
A. Managed solely by internal audit
B. Integrated into daily business processes
C. Focused only on low-frequency events
D. Designed independently of risk appetite

Q61.
If 3-month T-bill yield = 1.2% and 3-month LIBOR = 2.8%, what is the TED spread?
A. 1.4%
B. 1.6%
C. 1.8%
D. 2.0%

Q62.
In the LCR calculation, total net outflows = expected outflows – minimum of:
A. Expected inflows or 50% of outflows
B. Expected inflows or 75% of outflows
C. Expected inflows or 100% of outflows
D. Expected inflows or 25% of outflows

 

Q63.
Which best describes Net Stable Funding Ratio (NSFR)?
A. Short-term funding relative to trading assets
B. Stable funding relative to required stable funding over 1 year
C. CET1 relative to total RWA
D. Liquid assets relative to expected inflows

Q64.
Funds Transfer Pricing helps ALM primarily by:
A. Allocating liquidity and interest costs fairly across units
B. Reducing CET1 capital directly
C. Calculating Expected Loss
D. Managing FX positions

Q65.
If a bank funds a 7-year fixed loan with 1-year deposits, it is:
A. Asset-sensitive
B. Liability-sensitive
C. Market-neutral
D. Risk-free

Q66.
A bank hedges its Economic Value of Equity (EVE) using swaps. The purpose is to:
A. Immunize balance sheet from rate shocks
B. Increase earnings volatility
C. Reduce credit risk
D. Raise regulatory capital

Q67.
If duration gap is negative and interest rates rise, EVE will:
A. Increase
B. Decrease
C. Stay unchanged
D. First increase, then decrease

Q68.
Which Basel III buffer ensures banks retain earnings during stress?
A. Countercyclical buffer
B. Capital conservation buffer
C. G-SIB surcharge
D. Systemic liquidity buffer

Q69.
Which is a typical ICAAP scenario?
A. Parallel rate shifts, steepeners, and flatteners
B. Stock market collapse only
C. Sovereign default only
D. FX volatility only

 

Q70.
Basel II required banks to hold total capital ratio of at least:
A. 4%
B. 6%
C. 8%
D. 10%

Q71.
Which of the following qualifies as Tier 2 capital?
A. Retained earnings
B. Paid-up equity
C. Subordinated term debt
D. Common stock

Q72.
Which profits added to Tier 1 capital base are called “retentions”?
A. Distributable dividends
B. Net profits retained after provisions
C. Treasury trading gains
D. Unrealized revaluation reserves

Q73.
Which statement best differentiates economic vs regulatory capital?
A. Economic capital is internal, regulatory capital is externally mandated
B. Both are identical
C. Regulatory capital is always lower than economic capital
D. Economic capital is risk-insensitive

Q74.
Dodd-Frank Act stress tests (DFAST) require projections of:
A. CET1, Tier 1, Total Capital, and leverage ratios
B. Dividend payout ratios
C. Economic Value of Equity
D. VaR at 99% CL

Q75.
Rapid deterioration in current account deficit and rising external debt are early warning signs of:
A. Counterparty risk
B. Sovereign credit risk
C. Operational risk
D. Liquidity risk

Q76.
Liquidity contingency planning includes:
A. Securing committed lines and liquidating assets
B. Hedging Vega risk
C. Lowering CET1 ratio
D. Using only off-balance-sheet exposures

 

Q77.
Repos are commonly used to:
A. Increase core Tier 1 capital
B. Obtain short-term secured funding
C. Hedge counterparty credit risk
D. Eliminate duration gap

Q78.
If RWA = USD 250m, minimum CAR at 8% requires capital of:
A. USD 15m
B. USD 18m
C. USD 20m
D. USD 25m

Q79.
Basel III leverage ratio = Tier 1 capital ÷ ?
A. Total assets exposure
B. Risk-weighted assets
C. Tier 2 capital
D. CET1 capital

Q80.
Which reduces counterparty risk in OTC derivatives most effectively?
A. Central clearing through CCP
B. Increasing notional amounts
C. Extending maturity
D. Avoiding collateral agreements

 

📘FRR-Sample Paper 2 (Answers & Explanations)

 

 

Q1. B – EL = 0.03 × 0.45 × 120m = 1.62m.
Q2. C – Advanced IRB allows internal PD & LGD estimates.
Q3. C – Merton Model = structural, default if assets < debt.
Q4. A – EL = 0.04 × 0.40 × 500k = 8k
Q5. B – Joint PD = 8% × 8% = 0.64%.
Q6. A – Concentration = multiple loans to same group.
Q7. C – UL covered by economic capital.
Q8. C – Downgrade → higher RWA capital charge.
Q9. B – Cumulative PD ≈ 1 – (0.98^10) ≈ 18%.
Q10. B – Wrong-Way Risk = PD ↑ when exposure ↑.
Q11. C – Collateral lowers LGD, not EAD or PD.
Q12. B – Equity tranche absorbs first losses.
Q13. B – Systematic risk cannot be diversified away.
Q14. C – Higher PD under stress = stress testing.
Q15. A – Debt/GDP is key sovereign risk metric.
Q16. B – ICAAP (Pillar 2) accounts for correlations.
Q17. B – EL = 0.01 × 0.70 × 100m = 0.7m.
Q18. A – Same economy exposures = high correlation, less diversification.
Q19. C – UL reduced by diversification.
Q20. B – CreditRisk+ assumes defaults follow Poisson.

Q21. C – Net = 300 – 150 + 100 = 250m.
Q22. B – VaR ignores extreme tail risk.
Q23. C – Theta = time decay sensitivity.
Q24. C – Basket options → correlation risk.
Q25. C – Swap value = zero at inception.
Q26. B – 50m × 2% = 1m margin.
Q27. B – Index arbitrage → correlation risk.
Q28. A – Mapping aggregates into factor buckets.
Q29. A – Stress testing = extreme scenario analysis.
Q30. A – Loss > VaR → model underestimates risk.
Q31. B – VaR fails subadditivity.
Q32. A – Backtesting compares predicted vs actual losses.
Q33. B – Rogue trading → concealed losses & concentration.
Q34. B – RAROC = 6 ÷ 12 = 50%.
Q35. A – Volatility clustering = high vol → high vol.
Q36. B – Economic capital = internal buffer for UL.
Q37. A – Credit spread risk falls under market risk.
Q38. A – Duration/convexity ≈ Delta/Gamma.
Q39. A – Pay fixed, receive floating hedges liability sensitivity.
Q40. A – Steepener = short rates ↓, long rates ↑.

Q41. A – BIA = % of gross income.
Q42. B – Mis-selling = Clients, Products & Business Practices.
Q43. A – Ignoring limits = Internal Fraud.
Q44. B – Low-frequency cyberattacks = hardest to model.
Q45. B – Consortia provide external data for rare events.
Q46. B – Pandemic disruption = Business Disruption.
Q47. B – Motivational bias = outcomes favor own unit.
Q48. C – Internal Audit = 3rd line of defense.
Q49. A – Basel stresses Board sets tone/risk culture.
Q50. B – Cyberattack outage = Business Disruption.
Q51. B – Large hidden fraud = unexpected loss.
Q52. A – Settlement fails = Execution & Delivery.
Q53. A – KRIs = early warning indicators.
Q54. C – AMA requires 4th element = BEICFs.
Q55. A – Outsourcing often underestimates reputational risk.
Q56. C – Red light = only top-severity issues.
Q57. C – Pillar 3 = disclosure to market/public.
Q58. B – Misrepresentation to clients = Clients/Products risk.
Q59. A – Higher gross income → higher op risk capital.
Q60. B – Best when integrated into daily business.

Q61. B – TED = 2.8 – 1.2 = 1.6%.
Q62. B – Outflows – min(inflows, 75% outflows).
Q63. B – NSFR = ASF ÷ RSF ≥ 100% over 1 year.
Q64. A – FTP allocates cost of funds/liquidity.
Q65. B – Funding long assets with short liabilities = liability sensitive.
Q66. A – Hedging EVE immunizes against rates.
Q67. A – Negative Duration Gap → Liabilities’ duration > Assets’ duration.

When rates rise → liabilities’ market value falls more than assets’ → Assets – Liabilities gap widens → EVE increases.

Q68. B – Capital conservation buffer = 2.5% fully loaded.
Q69. A – ICAAP includes parallel, steepener, flattener scenarios.
Q70. C – Basel II CAR = 8% RWA.
Q71. C – Subordinated debt = Tier 2 capital.
Q72. B – Net retained profits = retentions.
Q73. A – Economic = internal, regulatory = imposed.
Q74. A – DFAST requires CET1, Tier 1, Total Capital, leverage.
Q75. B – External debt & CAD deterioration = sovereign risk.
Q76. A – Contingency = credit lines + asset liquidation.
Q77. B – Repos = secured short-term funding.
Q78. C – 250m × 8% = 20m.
Q79. A – Leverage ratio = Tier 1 ÷ total exposure.
Q80. A – Clearing via CCP reduces counterparty risk.