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FRM Part I · FRM Exam Part I · The Governance of Risk Management

A firm's board risk committee reviews a proposal for a new structured product. Management argues the product is highly profitable and the trading desk's model shows low VaR. Which response best reflects sound risk governance?

The best response is to require formal new-product approval including independent model validation, analysis of risks VaR may miss such as tail and liquidity risk, and a check against risk appetite. Relying on the desk's own low VaR and profit forecasts lacks independent challenge and ignores conflicts of interest.

  1. AApprove it because the VaR is low and the profit forecast is high
  2. BRequire a new-product approval process with independent risk validation of the model, assessment of risks VaR may miss such as tail and liquidity risk, and confirmation that it fits risk appetite before approvalCorrect
  3. CDelay review until after the product has been sold to see actual results
  4. DDelegate the decision entirely to the desk head who proposed it

Explanation

Good governance requires independent challenge: new-product approval with model validation, consideration of tail and liquidity risks not captured by VaR, and a check against risk appetite. Relying on the proposer's model and profit forecast ignores conflicts of interest. Post-sale review and desk-head delegation remove ex ante control.

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