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FRM Part II · FRM Exam Part II · The Investment Function in Financial Services Management

A bank's board sets a risk appetite that the 10-day 99% VaR of its investment portfolio must not exceed 2.0% of Tier 1 capital of $500 million. Management sets an early-warning trigger at 80% of the limit and a hard limit at 100%. The portfolio's 10-day 99% VaR is currently $8.6 million. Which statement is correct?

The hard limit is 2% of $500 million, or $10 million, and the early-warning trigger is 80% of that, $8 million. VaR of $8.6 million exceeds the trigger but remains under the limit, so escalation is needed without a hard-limit breach.

  1. AThe limit is $10 million, the trigger is $8 million, and the trigger has been breached but not the hard limitCorrect
  2. BThe limit is $10 million, the trigger is $8 million, and neither has been breached
  3. CThe limit is $8 million, the trigger is $6.4 million, and the hard limit has been breached
  4. DThe limit is $10 million, the trigger is $12.5 million, and neither has been breached

Explanation

Limit = 2.0% x $500m = $10m. Trigger = 80% x $10m = $8m. VaR of $8.6m exceeds the trigger but is below $10m, so escalation is required without a hard breach. Option C wrongly uses $8m as the limit; option D inverts the trigger calculation.

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