FRM (Financial Risk Manager) Foundations of Risk Management (Part I) Syllabus

Foundations of Risk Management (Part I) syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Foundations of Risk Management (Part I) in FRM (Financial Risk Manager), not a summary of it.

1. 1

   The Building Blocks of Risk Management

   4 topics

   • Concept and Typology of Risk
     • Expected vs. unexpected loss
     • Risk vs. reward trade-off
     • Known risks, unknown knowns, and unknown unknowns
   • Major Risk Classes
     • Market, credit, liquidity, and operational risk
     • Business, strategic, and reputational risk
     • Systemic risk and interconnectedness
   • The Risk Management Process
     • Identification, assessment, monitoring, and mitigation
     • Risk transfer, avoidance, and retention
   • Costs and Benefits of Risk Management
     • Reasons firms manage risk
     • Limitations and failures of risk management
2. 2

   Corporate Governance and Enterprise Risk Management

   4 topics

   • Corporate Governance Structures
     • Role of the board and risk committee
     • Three lines of defence model
   • Risk Appetite and Risk Culture
     • Defining risk appetite and tolerance frameworks
     • Aligning incentives and compensation with risk
   • Enterprise Risk Management (ERM)
     • Integrated firm-wide risk view
     • Scenario analysis and risk aggregation
   • Lessons from Financial Disasters
     • Barings, LTCM, Metallgesellschaft case studies
     • The 2007-09 Global Financial Crisis
3. 3

   Modern Portfolio Theory and Asset Pricing

   4 topics

   • Capital Asset Pricing Model (CAPM)
     • Capital market line and security market line
     • Systematic vs. idiosyncratic risk and beta
   • Performance Measurement Ratios
     • Sharpe, Treynor, and Sortino ratios
     • Jensen's alpha and the information ratio
   • Arbitrage Pricing Theory and Multifactor Models
     • Fama-French three-factor model
     • Factor risk premiums
   • Efficient Frontier and Diversification
     • Minimum variance portfolios
     • Correlation and risk reduction
4. 4

   Credit Risk Transfer and the Financial Crisis

   3 topics

   • Securitization Mechanics
     • Tranching and waterfall structures
     • Mortgage-backed securities and CDOs
   • Subprime Crisis Dynamics
     • Originate-to-distribute model
     • Role of credit rating agencies
   • GARP Code of Conduct
     • Professional integrity and ethical conflicts
     • Confidentiality and fundamental responsibilities

Foundations of Risk Management (Part I) flashcards for FRM (Financial Risk Manager)

21 of 51 cards from the Foundations of Risk Management (Part I) deck — real questions with worked answers.

1. Define "risk" in the context of financial risk management.

   Risk is the uncertainty surrounding future outcomes, specifically the potential variability or deviation of actual results from expected results, including the possibility of financial loss.

2. What is the key distinction between risk and uncertainty (Knightian distinction)?

   Risk refers to situations where outcomes are unknown but their probabilities can be quantified/measured, whereas uncertainty refers to situations where the probabilities of outcomes cannot be reliably assigned.

3. Distinguish between expected loss (EL) and unexpected loss (UL).

   Expected loss is the average/anticipated loss a firm expects over a period (a predictable cost of doing business, covered by pricing/reserves). Unexpected loss is the variability of losses around the expected value (covered by economic capital).

4. What is the formula for expected loss (EL) in credit risk?

   $$EL = PD \times EAD \times LGD$$ where $PD$ is probability of default, $EAD$ is exposure at default, and $LGD$ is loss given default.

5. How is unexpected loss typically defined statistically relative to expected loss?

   Unexpected loss is the standard deviation of losses around the expected (mean) loss, representing the dispersion of potential losses rather than the average.

6. How does a firm typically cover expected loss versus unexpected loss?

   Expected loss is covered through provisions, reserves, and pricing (built into product margins). Unexpected loss is covered by economic capital (a capital buffer held against adverse variability).

7. Explain the risk vs. reward trade-off.

   Higher potential returns generally require taking on higher risk; investors and firms must balance the level of risk accepted against the expected reward, accepting risk only when adequately compensated.

8. In Frank Knight's typology, contrast the three categories of risk awareness.

   Known risks (known knowns) are identified and measurable; unknown knowns are risks present but not recognized/acknowledged by the firm; unknown unknowns are risks that cannot be conceived of or anticipated in advance.

9. What is an "unknown known" risk and why is it dangerous?

   An unknown known is a risk that exists and could be identified but is overlooked, ignored, or suppressed (e.g., risks people prefer not to acknowledge). It is dangerous because the information exists but is not acted upon.

10. What is an "unknown unknown" risk?

    A risk that is entirely unforeseen and unimaginable in advance — outside the firm's experience and models — making it impossible to quantify or directly hedge before it materializes.

11. Name the four major financial risk classes.

    Market risk, credit risk, liquidity risk, and operational risk.

12. Define market risk and list its main subtypes.

    Market risk is the risk of loss from changes in market prices. Subtypes: interest rate risk, equity price risk, foreign exchange (currency) risk, and commodity price risk.

13. Define credit risk.

    Credit risk is the risk of loss arising from the failure of a counterparty or borrower to meet its contractual obligations (default), or from deterioration in its creditworthiness.

14. Distinguish the two main forms of liquidity risk.

    Funding liquidity risk: inability to meet cash-flow obligations/raise funds when due. Market (trading) liquidity risk: inability to sell or unwind a position quickly without significantly affecting its price.

15. Define operational risk and give its Basel scope.

    Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. It includes legal risk but excludes strategic and reputational risk.

16. Define business (or commercial) risk.

    Business risk is the risk a firm assumes voluntarily to create competitive advantage and add value — uncertainty about demand, input costs, technological change, and the firm's product markets and operating environment.

17. Define strategic risk.

    Strategic risk is the risk of significant losses arising from poor business decisions, flawed strategy, or failure to respond to industry/market changes (e.g., entering the wrong market or major investment errors).

18. Define reputational risk.

    Reputational risk is the risk of loss resulting from damage to a firm's reputation or brand, leading to lost revenue, customers, or increased costs — often a consequence of other risk events.

19. Define systemic risk.

    Systemic risk is the risk that the failure or distress of one institution or market triggers a cascade of failures across the broader financial system, threatening its overall stability.

20. How does interconnectedness amplify systemic risk?

    Tight linkages (counterparty exposures, common assets, payment systems) mean one institution's failure transmits losses to others, causing contagion, fire sales, and potential collapse of the whole system.

21. What does it mean for an institution to be "too big to fail" (TBTF)?

    An institution whose failure would cause such severe systemic disruption that governments feel compelled to bail it out, creating moral hazard by encouraging excessive risk-taking.

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