Glossary
FRM Glossary — key risk-management terms.
Plain-English definitions of every GARP FRM Part I and Part II term you need for the exam, with FRM-relevant examples and cross-links to tagged practice questions.
32 terms across 10 categories.
Market Risk
Value at Risk (VaR)
The loss threshold such that there is only a small probability (e.g. 1%) of the portfolio losing more than this amount over a given horizon.
FRM Part I+II
Expected Shortfall (ES)
The average loss conditional on the loss exceeding the VaR threshold — a coherent, more sensitive tail-risk measure than VaR.
FRM Part II
Delta-Normal VaR
A linear VaR approximation that uses the delta of each option to map non-linear positions into an equivalent linear exposure.
FRM Part II
VaR Backtesting
Comparing the model's VaR forecast against actual P&L to verify the model's accuracy and detect model risk.
FRM Part II
Investment
Sharpe Ratio
Excess return of a portfolio over the risk-free rate, per unit of total volatility — the classic risk-adjusted performance measure.
FRM Part I
Sortino Ratio
Like the Sharpe ratio, but uses downside deviation as the denominator — penalising only harmful volatility.
FRM Part I
Information Ratio (IR)
Active return divided by tracking error — the risk-adjusted performance measure for active managers vs a benchmark.
FRM Part I
Jensen's Alpha
The intercept of a portfolio's excess returns regressed on the market's excess returns — a CAPM-adjusted performance measure.
FRM Part I
Credit Risk
Credit Spread
The yield premium a bond pays over an equivalent-maturity risk-free benchmark, compensating investors for default and downgrade risk.
FRM Part I+II
Credit Valuation Adjustment (CVA)
The market value of the expected loss on a counterparty due to its potential default — subtracted from the unadjusted derivative value.
FRM Part II
Debit Valuation Adjustment (DVA)
The mirror of CVA — the value of one's own default risk embedded in a derivative liability.
FRM Part II
Exposure at Default (EAD)
The expected outstanding exposure on a contract at the moment the counterparty defaults — before any recovery.
FRM Part II
Loss Given Default (LGD)
The fraction of exposure that is lost when a borrower defaults, after collateral and recovery are considered — 1 minus recovery rate.
FRM Part II
Probability of Default (PD)
The likelihood that a borrower fails to make a scheduled payment over a given horizon — the foundation of credit-risk modelling.
FRM Part II
Credit Default Swap (CDS)
An insurance contract where the buyer pays a periodic premium and is compensated if a reference entity defaults.
FRM Part I+II
Merton Structural Model
Models default as the firm's asset value falling below a debt barrier — the Black–Scholes-style structural credit model.
FRM Part II
Valuation
Duration (Macaulay / Modified)
The weighted-average time to a bond's cash flows (Macaulay) and the percentage price sensitivity to a 1% yield change (Modified).
FRM Part I
Convexity
The second derivative of bond price with respect to yield, scaled by price — captures the curvature that duration alone misses.
FRM Part I
Black–Scholes
The closed-form option-pricing model assuming geometric Brownian motion, constant volatility, and continuous trading.
FRM Part I
Delta (Greek)
The rate of change of an option price with respect to the underlying price — the option's effective share exposure.
FRM Part I
Vega (Greek)
The rate of change of an option price with respect to implied volatility — how much an option gains for a 1-point vol move.
FRM Part I
Quantitative
ARCH / GARCH
Time-series models that let volatility cluster — conditional variance is a function of past squared returns (ARCH) and past variance (GARCH).
FRM Part I
Exponentially Weighted Moving Average (EWMA)
A recursive volatility estimator that gives recent returns more weight via a decay factor λ — the RiskMetrics λ = 0.94 default.
FRM Part I
Copula
A function that joins univariate marginal distributions into a joint distribution — the standard tool for modelling asset dependence.
FRM Part I