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Nicole Seaman

Director of FRM Operations
Staff member
Learning outcomes: Describe the three fundamental dimensions behind risk management, and their relation to VaR and tracking error. Describe risk planning, including its objectives, effects, and the participants in its development ... Describe the objectives of performance measurement tools. Describe the use of alpha, benchmarks, and peer groups as inputs in performance measurement tools.


21.9.1. Acme Industrial Corporation just finished establishing its new financial accounting controls which include three components: planning, budgeting, and variance monitoring. The company's next step is to establish a three-legged risk management stool that will analogously include the risk plan, the risk budget, and the risk monitoring process. In regard to the risk plan, each of the following will be an element EXCEPT which is the LEAST likely to be included in Acme's risk plan?

a. Diversification or risk decomposition policy
b. Strategic responses for events that are low-probability but franchise-threatening
c. Ample budget for losses that are material, predictable, and avoidable that cascade down
d. Identification of critical dependencies that exist inside and outside the organization

21.9.2. Acme Investment Bank recently recovered from a high-profile, high-severity trading loss that could have been avoided with adequate risk management. Among their efforts to elevate the organization's risk consciousness, the bank has formed an independent risk management unit (RMU). Each of the following is likely to be among the responsibilities of the RMU EXCEPT which is not likely to be true (as a responsibility of the RMU)?

a. The RMU should ascertain if the bank's risk forecasting model is behaving as predicted
b. The RMU should raise a yellow (or red) flag when any fund exceeds a liquidity duration of 15.0%
c. The RMU should identify style drift by asking whether risk capital is spent in expected themes
d. The RMU should compare each fund manager's forecasted tracking error with the bank's tracking error budget(s)

21.9.3. Acme Investment Bank recently finished building the third leg of its three-legged risk management stool, after the risk plan and the risk budget: the bank installed its risk monitoring process. The bank shares a belief with the authors (Rosengarten and Zangari) that "risk is the shadow cost behind returns." Each of the following is probably an element or plank in the bank's risk monitoring process EXCEPT which is the least likely to be found in the bank's risk monitoring process?

a. The bank's monitoring is not dependent on any single tool or metric, but instead relies on an ensemble of various tools and metrics
b. The bank measures alpha as a regression intercept where alpha can help evaluate manager skill but unfortunately, its statistical significance often requires more data (i.e., longer history) than is available
c. The bank measures return on risk capital (RORC)) where value at risk (VaR) is a measure of risk capital; in addition to the RORC's level, the bank watches its variability
d. After a threshold level of data is collected, subjective articulations of each portfolio manager's philosophy becomes unnecessary, and should be discarded, in favor of quantitative performance evaluation

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