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FRM Part II

Prepare for FRM Part II with FRM practice questions covering 52 topics. Build your knowledge, track your progress, and study effectively with Pass FRM.

Questions
2,609
Units
6
Topics
52

What’s in it.

6 units

Sample questions

3 of many

A few questions from this module, with the answer and a full explanation. The complete bank is available when you start practising.

  1. A trading desk passes all VaR backtesting requirements under FRTB but fails the P&L attribution test. What are the regulatory consequences, and why can a desk fail the PLA test while passing backtesting?

    • The desk must use the standardised approach (SA) for capital, even though it passed backtesting. This is because P&L attribution tests model accuracy vs. actual trading P&L — failing it means the model does not adequately explain desk-level P&L, which is a separate criterion from calibration.
      Correct answer
    • The desk must switch to IMA using ES rather than VaR, which automatically passes the PLA test
    • No consequences; failing the PLA test with passing backtesting results is treated as a minor finding and disclosed to the regulator without capital impact
    • The desk must revise its VaR model but can continue using IMA pending the revision
    Explanation

    Under FRTB, both the P&L attribution test and VaR backtesting must be passed for a desk to retain IMA. Failing the PLA test forces the desk to the standardised approach (SA), regardless of backtesting results. The key insight: backtesting validates calibration (does the model correctly estimate the P&L distribution?), while the PLA test validates completeness (does the model include all risk factors that actually drive P&L?). A desk can have a well-calibrated but incomplete model, passing one test and failing the other.

  2. What is the Greenspan-Guidotti rule for foreign exchange reserve adequacy and what ratio does it require?

    • The Greenspan-Guidotti rule requires a sovereign to hold foreign exchange reserves equal to at least 100% of its short-term external debt (debt maturing within one year), ensuring the sovereign can service all near-term external obligations without recourse to capital markets
      Correct answer
    • The Greenspan-Guidotti rule requires reserves to exceed total external debt (both short-term and long-term), providing a two-year buffer against complete capital market closure
    • The Greenspan-Guidotti rule requires foreign exchange reserves equal to at least 5% of GDP, based on historical analysis of sovereign crises by the IMF
    • The Greenspan-Guidotti rule requires foreign exchange reserves equal to at least 20% of broad money (M2), reflecting the risk of a domestic banking run triggering capital flight
    Explanation

    The Greenspan-Guidotti rule (named after Federal Reserve Chairman Alan Greenspan and Argentine Deputy Finance Minister Pablo Guidotti) states that a sovereign should maintain foreign exchange reserves sufficient to cover 100% of external debt maturing within one year. The rationale: in a sudden stop (where international capital flows cease abruptly), a sovereign that can repay all near-term external obligations from reserves can survive without market access for at least one year — typically enough time to implement adjustment policies and regain market access. This metric became important after the 1997–2000 EM sovereign crises. Reserve adequacy assessments also include: import cover (IMF recommends ≥3 months), M2 coverage (for banking system vulnerability), and total external debt coverage. Countries that fell below Greenspan-Guidotti levels (Thailand 1997, Argentina 2001) faced severe crises.

  3. A bank offers fixed-rate savings accounts that allow customers to withdraw their funds without penalty at any time. Interest rates have just risen sharply. What type of IRRBB risk does this product create, and what is the likely direction of the bank's exposure?

    • Repricing risk — the savings accounts will reprice upward automatically with market rates, creating NII compression
    • Optionality risk — if rates rise, customers may withdraw (exercising the embedded put option) to reinvest at higher rates, creating unexpected funding outflows for the bank
      Correct answer
    • Repricing risk — the savings accounts will be repriced by the bank at a time of its own choosing, not driven by customer behaviour
    • Yield curve risk — the steepening of the yield curve affects the value of the fixed-rate savings products
    Explanation

    Fixed-rate savings accounts with no early withdrawal penalty contain an embedded put option held by the depositor. When rates rise, customers rationally withdraw and move funds to higher-rate products — this is optionality risk. The bank faces an adverse, one-sided exposure: customers exercise the option exactly when it costs the bank most (unexpectedly losing stable funding when replacement funding is more expensive). This is analogous to mortgage prepayment risk but on the liability side. The exposure is adverse to the bank, not favourable.