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

A bank's risk appetite statement caps the 12-month net interest income decline at 5% under a +200 bp shock. The investment portfolio manager proposes buying long-dated fixed-rate bonds for extra yield. Which action best reflects a sound risk appetite framework?

The proposal should be evaluated by its impact on the portfolio's aggregate NII sensitivity to a +200 bp shock and approved only if the total stays within the 5% cap. Higher yield or government issuance does not eliminate interest rate risk, and a blanket ban is unnecessarily rigid.

  1. AApprove the purchase because yield enhancement always raises net interest income
  2. BAssess the purchase's effect on the +200 bp NII sensitivity and approve only if the aggregate stays within the capCorrect
  3. CApprove the purchase since the bonds are government-issued, so interest rate risk is irrelevant
  4. DReject all purchases of fixed-rate bonds regardless of the measured impact

Explanation

The limit is on aggregate NII sensitivity, so the proposal must be measured against it. Higher yield does not remove rate risk, and government issuers carry little credit risk but still full interest rate risk. A blanket ban ignores that the limit may still be met.

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