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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

A firm follows a structured risk management process. After identifying its risks, it measures a currency exposure and decides to hedge half of it with forwards. Which step in the process should logically come next?

The next step is monitoring and reporting. After identifying, measuring and treating the exposure with a partial hedge, the firm must track hedge effectiveness and residual risk against its limits. Skipping this would leave the unhedged half and basis risk unmanaged.

  1. AMonitoring the hedge and reporting results against risk limitsCorrect
  2. BRe-identifying the same currency risk from scratch
  3. CAbandoning measurement because hedging is already decided
  4. DRemoving all risk limits since the exposure is partly hedged

Explanation

The process runs through identification, assessment/measurement, treatment (such as hedging), then monitoring and reporting. After the hedge decision, monitoring effectiveness and residual exposure against limits is the next step. Dropping limits or measurement would leave residual risk unmanaged.

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