2026 FRM Part 2 Free Practice Questions: Check Your Readiness Before Exam Day

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Preparing for the 2026 FRM Part II exam means going beyond theory and testing how well you can apply risk management concepts in exam-style scenarios. These free practice questions are designed to help you check your readiness, identify weak areas, and build confidence before exam day. Use them to see where you stand and focus your revision on the topics that need the most attention. 2026 FRM Part 2 Free Practice Questions

1) Backtesting and contaminated returns

A bank’s market risk team backtests its daily 99% VaR using two return series. Using a frozen-portfolio hypothetical return series, the model passes. Using actual daily P&L, the model fails. During the test window, the trading desk was highly active intraday and fee income was unusually strong.

Which conclusion is most appropriate?

A. The VaR model is definitely misspecified, and intraday trading is irrelevant.

B. The main issue is likely contamination from intraday trading and other non-mark-to-market effects.

C. The model should only be backtested on actual returns because hypothetical returns are not useful.

D. The result proves the bank is overstating risk.

2) Unconditional versus conditional coverage

A bank reports a daily 95% VaR. Over 252 trading days, it records 13 exceptions, but 10 of those exceptions occur during a two-week period after a volatility regime shift.

Which statement is most accurate?

A. The model clearly passes because 13 exceptions are close to the unconditional expectation.

B. The clustering is a red flag because acceptable unconditional coverage does not ensure conditional coverage.

C. The model can only be rejected if the total number of exceptions exceeds 17.

D. The clustering implies the model is too conservative.

3) Through-the-cycle versus point-in-time

A large credit rating agency wants ratings that remain relatively stable through short-lived recessions so that bond investors are not forced into frequent trading. A commercial bank wants a rating system for short-term revolving credit that updates quickly when borrower conditions change.

Which pairing is most appropriate?

A. Rating agency: point-in-time; bank: through-the-cycle

B. Rating agency: through-the-cycle; bank: point-in-time

C. Rating agency: through-the-cycle; bank: through-the-cycle

D. Rating agency: point-in-time; bank: point-in-time

4) Behavioral scoring versus profit scoring

A retail lender is reviewing an existing credit-card customer. First, it wants a score that updates monthly using missed payments, balances, and employment changes. Second, it wants to evaluate whether increasing the customer’s credit line is profitable when considering the customer’s mortgage, auto loan, and card relationship together.

Which combination best fits the two tasks?

A. Issue-specific rating and account-level profit scoring

B. Behavioral scoring and customer-level profit scoring

C. Issuer rating and account-level profit scoring

D. Behavioral scoring and account-level profit scoring

5) Wrong-way correlation risk in CDS hedging

An investor buys Spanish government bonds and hedges the exposure with a CDS sold by a major European bank. During a regional sovereign crisis, the credit quality of both Spain and the CDS seller deteriorates together.

Which statement is most accurate?

A. Higher positive default correlation increases the value of the CDS to the buyer because both credit spreads widen together.

B. Higher positive default correlation reduces the value of the CDS to the buyer, and at perfect correlation the CDS can become worthless.

C. Correlation affects only bond prices, not CDS valuation.

D. Negative default correlation always makes the CDS less valuable to the buyer than positive correlation.

6) Correlation book capital under Basel 2.5

A bank holds BBB-rated re-securitization tranches in its correlation book. The desk argues that the incremental risk charge is sufficient. The supervisor responds that the relevant capital treatment was introduced because tranche values are highly sensitive to changing correlations and that re-securitizations receive much higher standardized capital charges than ordinary securitizations.

Which capital treatment is the supervisor referring to?

A. Stressed VaR

B. Incremental risk charge

C. Comprehensive risk charge

D. Leverage ratio capital requirement

7) Sharp and forward-looking EWIs 2026 FRM Part 2 Free Practice Questions

A bank’s treasury dashboard shows total deposits are flat month over month. However, high-net-worth and rate-sensitive balances are declining rapidly, call-center traffic is surging, and counterparties are asking for additional collateral.

What is the best interpretation?

A. Aggregate deposits are stable, so liquidity risk has not increased.

B. The bank should focus mainly on external macro indicators and ignore segment-level changes.

C. These are the kinds of sharp, forward-looking EWIs that should trigger escalation and documented management action.

D. EWIs only matter after the LCR falls below the regulatory minimum.

8) Altman Z-score

A publicly traded manufacturing company has the following financial data:

Working capital = 120,000
Total assets = 800,000
Retained earnings = 80,000
EBIT = 64,000
Market value of equity = 225,000
Book value of total liabilities = 300,000
Sales = 1,360,000

Using Altman’s original Z-score model, what is the Z-score and the most appropriate interpretation?

A. 2.732300; on alert

B. 2.732300; high chance of default

C. 3.002300; unlikely to default

D. 1.732300; very high probability of financial embarrassment

9) Hazard rate implied by a CDS spread

A firm’s five-year CDS spread is 180 basis points, and the expected recovery rate is 40%. Assume the average hazard rate is constant over the five-year horizon.

What are the implied average hazard rate and the cumulative probability of default by year 5?

A. 1.800000% and 8.607080%

B. 3.000000% and 13.929202%

C. 3.000000% and 15.000000%

D. 4.500000% and 20.475000%

10) Quantitative: Basel 2.5 market risk capital

A bank reports the following figures (in USD millions):

Previous-day 10-day VaR = 14
60-day average 10-day VaR = 5
Previous-day stressed VaR = 17
60-day average stressed VaR = 6
Multiplier on VaR = 3
Multiplier on stressed VaR = 4

Using the Basel 2.5 market risk capital formula, what is the total capital charge?

A. 31

B. 32

C. 39

D. 41

Answer Key with Explanations:

1) Correct answer: B

VaR is intended to measure risk on a frozen portfolio. Hypothetical returns are therefore the cleaner match to the VaR forecast, while actual returns include intraday trading, fees, commissions, spreads, and other non-mark-to-market items. If the model passes on hypothetical returns but fails on actual returns, the most likely issue is contamination from intraday activity rather than the core VaR methodology itself.

2) Correct answer: B

A model can look acceptable on unconditional coverage and still fail conditional coverage. The key problem here is clustering: exceptions should not bunch abnormally if the model is well calibrated for current conditions. A concentrated burst of exceptions suggests time-varying risk is not being captured, even if the total count looks roughly right.

3) Correct answer: B

Through-the-cycle ratings are designed to be stable across short-term fluctuations and are primarily associated with major rating agencies. Point-in-time ratings are more volatile, update more quickly, and are better suited to internal bank systems and short-term lending decisions.

4) Correct answer: B

Behavioral scoring is used for existing customers and is updated frequently using observed behavior such as balances, missed payments, and status changes. Customer-level profit scoring evaluates profitability across all accounts held by the customer, not just one product.

5) Correct answer: B

This is wrong-way risk. As default correlation between the reference entity and the CDS seller rises, the protection becomes less valuable because the seller is more likely to fail when protection is needed most. In the extreme case of perfect correlation, the CDS can become worthless because the seller defaults when the reference entity defaults.

6) Correct answer: C

The comprehensive risk charge was introduced for the correlation book because tranche values, especially for securitizations and re-securitizations, can change sharply when correlations move. Under the standardized approach, re-securitizations attract materially higher charges than securitizations of the same rating.

7) Correct answer: C

Good EWIs should be forward-looking and sharp. A flat aggregate deposit number can hide deterioration in more volatile funding segments. Falling high-net-worth and rate-sensitive balances, rising call-center activity, and increasing collateral requests are exactly the kinds of indicators that should trigger escalation and formal management discussion.