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

A manufacturer uses ERM to evaluate its currency risk and commodity input risk. It finds that the two risks are negatively correlated, so that the combined earnings volatility is lower than the sum of the stand-alone volatilities. Which ERM benefit does this finding illustrate?

This illustrates portfolio diversification benefits captured through integrated risk aggregation. Because the risks are negatively correlated, combined earnings volatility is below the sum of stand-alone volatilities, a natural offset that silo management would miss, enabling more efficient hedging and capital use.

  1. ARisk transfer through insurance
  2. BRisk avoidance by exiting the business line
  3. CPortfolio diversification effects recognized through integrated risk aggregationCorrect
  4. DElimination of the need to set risk limits

Explanation

Aggregating risks firm-wide reveals natural offsets and diversification, so total risk is less than the sum of the parts when correlations are below one. This is a benefit of integrated measurement, not insurance or avoidance. Firms still need limits, so the last option is wrong.

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