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

A bank's investment policy sets a limit on the portfolio's effective duration of 4.0 years. The treasurer wants to buy long-dated bonds to raise yield. Which control is the most appropriate way for the risk appetite framework to cascade this constraint into daily practice?

The risk appetite should be cascaded into desk-level limits, with ongoing monitoring and escalation triggers when breaches occur. This turns the board's duration tolerance into enforceable daily practice, unlike a lone income target, outsourced rating monitoring or rare rate-triggered reviews.

  1. ASetting a single annual target for portfolio net income, with no sub-limits
  2. BTranslating the board-level duration tolerance into desk-level limits with monitoring and escalation triggers for breachesCorrect
  3. CRelying on external rating agencies to flag excessive duration
  4. DReviewing the duration limit only when interest rates rise by more than 200 basis points

Explanation

An effective framework cascades board-level tolerance into operational limits, with regular monitoring and escalation procedures. An income target alone does not constrain duration, rating agencies do not monitor bank policy limits, and ad hoc review is not continuous control.

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