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

A bank's risk appetite framework uses a hierarchy of board-level appetite metrics, management limits and desk-level triggers. The portfolio's duration limit is 4.0 years with an early warning trigger at 3.6 years. Portfolio is USD 500 million with duration 3.7 years. A 100 bp parallel rate rise is expected to reduce value approximately by modified-duration times change. Which statement is correct?

The early warning trigger at 3.6 years has been crossed, though the 4.0-year limit has not, so escalation is required. The approximate loss from a 100 bp rise is 3.7 x 1% x USD 500 million, or USD 18.5 million.

  1. AThe trigger has been hit, escalation is required, and the approximate value loss from a 100 bp rise is about USD 18.5 millionCorrect
  2. BThe limit is breached and the approximate loss is USD 20 million
  3. CNo action is needed and the approximate loss is USD 1.85 million
  4. DThe trigger has been hit and the approximate loss is USD 185 million

Explanation

Duration 3.7 exceeds the 3.6 trigger but is below the 4.0 limit, so escalation (not a breach) applies. Loss approx 3.7 x 1% x 500 = USD 18.5 million. Option 2 uses the limit duration and calls a breach; option 3 and 4 misplace the decimal.

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