Skip to content

FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A pension fund sets a total active risk budget of 4% tracking error and allocates it among three external managers. Which statement best describes the purpose of this risk budgeting process?

Risk budgeting distributes the fund's overall risk tolerance, such as a tracking error limit, among managers and strategies according to where expected return per unit of risk is greatest. It guides allocation and monitoring but does not guarantee outperformance or require equal splits.

  1. AIt assigns the fund's limited tolerance for active risk to the managers and strategies where the fund expects the best return per unit of riskCorrect
  2. BIt guarantees that each manager will outperform its benchmark by at least the amount of risk allocated
  3. CIt eliminates the need to monitor realized risk because limits are fixed in advance
  4. DIt requires equal risk allocations to all managers regardless of skill

Explanation

Risk budgeting allocates scarce risk capacity, such as tracking error or VaR, across managers and strategies in line with expected reward. It does not guarantee outperformance, remove monitoring, or require equal allocations.

Did you get it right without looking?

One question tells you little. A timed set on VaR and Risk Budgeting in Investment Management shows your real accuracy, how long you take and where you lose marks.

Practise VaR and Risk Budgeting in Investment ManagementFree diagnostic mock

More VaR and Risk Budgeting in Investment Management questions