Reading 37: Risk Management －LOS aCFA Institute Area 3-5, management, contrast, features

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 12: Risk Management
Reading 37: Risk Management
LOS a: Compare and contrast the main features of the risk management process, risk governance, risk reduction, and an enterprise risk management system.

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Which of the following is the most difficult step in establishing an enterprise-wide risk management (ERM) system for a large firm?

A) Creating a centralized data warehousing system.

B) Establishing a monitoring and evaluation system.

C) Developing an analytics system.

D) Producing summary reports for the appropriate decision makers.

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Answer and Explanation

Establishing a centralized data warehousing system is the most difficult step in an ERM system because it involves coordinating an enormous amount of information from potentially different data systems requiring the output to be standardized and comparable across the institution.

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Which of the following operations applies to the monitoring and evaluation systems of an enterprise-wide risk management (ERM) system?

A) Performing diagnostics on the pricing, value at risk (VAR) computations, and data quality.

B) Computing value at risk (VAR) metrics for all risks across the firm.

C) Standardizing all data to ensure consistency across business units.

D) Computing stress testing to complement traditional value at risk (VAR) based risk measures.

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Answer and Explanation

Monitoring and evaluation includes the ability to easily identify data problems, identify position limit violations, perform diagnostics on pricing and VAR measures computed by the analytics system, and allow for risk adjustments and performance evaluation.

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Yoshi Chu and Ryan Dobson have been tasked with creating an enterprise-wide risk management (ERM) system for Reliant Financial Services. After creating a centralized data warehousing facility, their next step is creating a useful analytics system. Which of the following features would be least likely included in their system?

A) Derivative valuation models.

B) Monte Carlo simulations.

C) Legal risk analysis.

D) Historical value at risk (VAR) calculations.

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Answer and Explanation

A useful analytics system for an ERM is used for assessing risk, not valuing individual assets. The useful system would include several VAR methodologies including historical VAR and Monte Carlo simulation, credit risk analysis, liquidity risk analysis, operational risk analysis, and legal risk analysis.

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Which of the following is the final step in the risk management process?

A) Identifying and measuring specific risk exposures.

B) Setting specific tolerance levels.

C) Monitoring the process and taking any necessary corrective actions.

D) Reporting risk exposures (deemed appropriate) to stakeholders.

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Answer and Explanation

The risk management process is a continual process of:

• Identifying and measuring specific risk exposures.
• Setting specific tolerance levels.
• Reporting risk exposures (deemed appropriate) to stakeholders.
• Monitoring the process and taking any necessary corrective actions.

The risk management process is a continual process of:

• Identifying and measuring specific risk exposures.
• Setting specific tolerance levels.
• Reporting risk exposures (deemed appropriate) to stakeholders.
• Monitoring the process and taking any necessary corrective actions.

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Risk management is best addressed:

A) daily.

B) monthly.

C) quarterly.

D) annually.

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Answer and Explanation

Risk management is a continuous process; therefore addressing it more frequently is better.

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One goal of all risk management systems should be to:

A) eliminate all risk, i.e., reduce risk to zero.

B) make the risk level equal to the prevailing level in the market.

C) bring the level of risk to a desired level of risk, which may exceed zero.

D) allow traders risk self-governance.

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Answer and Explanation

Since return and risk go together, risk managers should determine the appropriate level of risk that is acceptable. The acceptable level should be based upon the nature of the firm and the risk tolerance of the stakeholders. Those that manage risk should be separate from those that take the risks.

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Risk management has evolved into:

A) a series of small sets of independent activities.

B) a broad set of interrelated activities.

C) the single activity of hedging risk.

D) a government mandated set of standards.

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Answer and Explanation

Risk management was once simply thought as hedging risk. Now managers must look at it from several perspectives. Various types of risks must be defined, measured and selectively managed. A desired level of risk must be selected and the actual risk monitored to see if it is in line with that selected level.

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The final step in the implementation phase of the risk management process is to:

A) determine the optimal time to wait for addressing risk again.

B) liquidate all the assets determined to be risky.

C) identify and price the appropriate tools for achieving the objectives.

D) conduct a Monte Carlo simulation.

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Answer and Explanation

After setting goals and assessing the current level of risk, the firm needs to see if the goals can be achieved cost-effectively. There is no waiting in risk management because it is an ongoing procedure. The Monte Carlo simulation may be involved in risk management, but it is certainly not the final step. Liquidating risky assets is a nonsensical conceptthere must be risk for there to be return.

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Each of the following is a step in the risk management process EXCEPT:

A) identifying the current level of risk.

B) setting a target level of risk.

C) monitoring the risk exposure.

D) filing taxes.

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Answer and Explanation

There are five parts of the process: identify the desired level of risk, determine the current level of risk, bring the current level in line with the desired level, monitor the risk exposure to keep it line with the desired level, and alter the process to reflect new information, policies and preferences.