[ 2009 FRM Sample Exam ] Operational and Integrated risk management Q4 reputation, limitation, all, management, its

Abey

 

4. Which of the following statements are valid about hedging operational risk?

i) A primary disadvantage of insurance as an operational risk management tool is the limitation of policy coverage.

ii) If an operational risk hedge works properly, a firm will avoid damage to its reputation from a high-severity operational risk event.

iii) While all insurance contracts suffer from the problem of moral hazard, deductibles help reduce this problem.

iv) Cat bonds allow a firm to hedge operational risks associated with natural disasters.

A. i, iii and iv only

B. i, ii and iv only

C. ii and iii only

D. iii and iv only

Abey

 

Correct answer is Afficeffice" />

(i) is VALID ? since high severity operational risk events can result in devastating losses, these losses are often uninsurable.

(ii) is NOT VALID ? regardless of how well an operational risk hedge works to offset losses from a risk event, the firm will generally suffer enormous damage to its reputation.

(iii) is VALID ? while insurance contracts provide incentive to partake in risky behavior, deductibles help to better align the interests of the insurers and insured. 

(iv) is VALID ? cat bonds allow a firm to raise money to be tapped in the event of a natural disaster. 

Reference: Allen, Boudoukh and Saunders, Understanding Market, Credit and Operational Risk: The Value at Risk Approach, Chapter 5, pp. 186 ? 196.