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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A firm's strategy team proposes entering a new market with high expected returns but highly uncertain outcomes. Under an ERM approach to the risk-return trade-off, what is the most appropriate step for the board before approving?

The board should test the proposal against the firm's risk appetite and available capital, using risk-adjusted return measures and downside scenario analysis. Expected return alone ignores risk, and strategic risk is difficult but not impossible to assess, so it should be governed enterprise-wide rather than ignored or delegated.

  1. AAssess the proposal against the firm's risk appetite and capital, evaluating risk-adjusted returns and downside scenariosCorrect
  2. BApprove it because the highest expected return always maximizes shareholder value
  3. CReject it because strategic risks cannot be measured
  4. DDelegate the decision to the business unit since risk is managed only at the unit level

Explanation

ERM links strategy to risk appetite, capital and risk-adjusted performance, using scenario analysis where measurement is hard. Expected return alone ignores risk, and strategic risk is managed at the enterprise level, not dismissed or fully delegated.

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