FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management
A firm has Tier 1 capital of USD 500 million. Its board sets a risk appetite that annual stress losses should not exceed 12% of capital. Stress testing estimates a 1-in-25-year loss of USD 72 million. What is the firm's position relative to appetite?
The firm is outside its appetite by USD 12 million. The limit is 12% of USD 500 million, or USD 60 million, while the estimated stress loss is USD 72 million, exceeding the limit by USD 12 million.
- AWithin appetite, with USD 12 million of headroomCorrect
- BWithin appetite, with USD 60 million of headroom
- COutside appetite by USD 12 million
- DOutside appetite by USD 72 million
Explanation
Appetite limit = 12% x 500 = USD 60 million. Stress loss is USD 72 million, which exceeds 60 by 12 million. So the firm is outside appetite by USD 12 million. Option 'within appetite with 12 headroom' is wrong because it reverses the sign.
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