Free GARP FRM Part I Foundations of Risk Management Practice Questions
Foundations of Risk Management carries 20% of GARP FRM Part I (GARP). Questions cover the building blocks of risk (expected versus unexpected loss, the classes of risk and how they interact), how firms and boards govern risk, credit risk transfer, CAPM and multifactor models, data aggregation and risk reporting principles, enterprise risk management, the financial disasters case studies, the anatomy of the 2007-2009 crisis, and the GARP Code of Conduct.
How does the Sortino ratio differ from the Sharpe ratio?
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Correct Answer: C
Solution
C is correct. The Sortino ratio penalizes only downside volatility. It divides the excess return above a minimum acceptable return (MAR) by the downside deviation, the square root of the average squared shortfall below the MAR, N1∑t=1Nmin(Rt−MAR,0)2, where periods at or above the MAR count as zero shortfall. The Sharpe ratio instead divides excess return over the risk-free rate by total standard deviation, so upside volatility also lowers it.
Question 2
Medium
The failure of Northern Rock in 2007 most directly illustrates which type of risk?
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Correct Answer: C
Solution
C is correct. Northern Rock funded a large book of mortgages heavily through short-term wholesale borrowing and securitization rather than stable retail deposits. When the interbank and securitization markets seized up in 2007, it could not roll its short-term funding, triggering a liquidity crisis and ultimately a retail deposit run. The lesson is the danger of a maturity mismatch that depends on continuous access to wholesale funding.
Question 3
Hard
The 2012 JPMorgan "London Whale" episode is most instructive as a warning about which combination of failures?
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Correct Answer: B
Solution
B is correct. The Chief Investment Office accumulated a large, concentrated synthetic credit-derivatives position while a newly implemented VaR model understated the risk, and valuation and control weaknesses allowed losses to accumulate before they were recognized. Unlike Barings, the traders acted within delegated authority; the failure was model risk plus inadequate independent oversight and position-limit discipline.
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