Foundations of Risk Management

FRM® Part I, published weight 20%. Risk taxonomy, governance, CAPM, multifactor models, financial disasters.

What the outline covers

Risk types, and the tools used to measure and manage them
Risk governance: board and audit responsibilities, risk appetite, ERM
Credit risk transfer mechanisms
CAPM and risk-adjusted performance measurement
Multifactor models
Risk data aggregation and risk reporting
Financial disasters and case studies; lessons of the global financial crisis
GARP Code of Conduct

Sample questions

These 5 questions are free in the app too. Try each one before opening the answer.

Question 1

A portfolio has a return of 12%, a standard deviation of 18% and a beta of 1.2. The risk-free rate is 3%. Its Treynor ratio is closest to:

R_p 12% · σ 18% · β 1.2 · R_f 3%

A. 0.050
B. 0.075
C. 0.090
D. 0.500

Show the answer

B. Treynor = (R_p − R_f)/β = (12% − 3%)/1.2 = 0.075. The Sharpe ratio, using σ, would be 0.50.

Reading: Foundations of Risk Management — Risk-Adjusted Performance

Question 2

The collapse of Barings Bank is most directly attributed to:

A. An unhedged commodity basis exposure
B. A single trader controlling both trading and settlement functions
C. A liquidity mismatch in the repo book
D. A model error in option pricing

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B. The failure was one of governance: Nick Leeson controlled both the front and back office, so losses could be concealed. The trade itself was secondary.

Reading: Foundations of Risk Management — Financial Disasters

Question 3

Two portfolios show identical Sharpe ratios but different Treynor ratios. This most likely indicates that:

A. One portfolio holds significant undiversified specific risk
B. One portfolio is leveraged
C. The risk-free rate was measured differently
D. Both portfolios are fully diversified

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A. For fully diversified portfolios the two measures rank identically. Divergence implies specific risk in one portfolio that beta does not capture.

Reading: Foundations of Risk Management — Risk-Adjusted Performance

Question 4

Under an enterprise risk management framework, the primary responsibility for setting risk appetite lies with:

A. The chief risk officer
B. The board of directors
C. Internal audit
D. The trading desk heads

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B. The board sets risk appetite; management translates it into limits and the risk function monitors adherence. Audit provides independent assurance.

Reading: Foundations of Risk Management — Risk Governance

Question 5

A risk that can be transferred at a known cost, such as a hedgeable currency exposure, is best managed by:

A. Holding economic capital against it
B. Hedging it
C. Scenario analysis only
D. Accepting it as an unknown unknown

Show the answer

B. Known and hedgeable risks are hedged. Capital covers quantifiable but unhedged risk; scenario analysis addresses the unknown unknowns.

Reading: Foundations of Risk Management — Risk Taxonomy

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