CFA Level I · CFA Level I Exam · Introduction to Risk Management
A pension fund's board finds that its willingness to accept losses is high, but its liabilities are due soon and its funding surplus is thin. The fund's overall risk tolerance is most likely determined by:
The fund's risk tolerance is determined by the more restrictive of its willingness and ability to take risk. Here the board is willing, but near-term liabilities and a thin surplus limit its capacity to absorb losses, so ability is the binding constraint and tolerance should be set lower.
- Aits willingness to take risk, since this is the binding constraint
- Bthe more restrictive of its willingness and its ability to take riskCorrect
- Cits ability to take risk, but only if it exceeds willingness
Explanation
Risk tolerance combines willingness (attitude) and ability (financial capacity) to take risk. When they conflict, the lower, more restrictive one should govern. Here the thin surplus and near-term liabilities limit ability, so the high willingness cannot be relied on.
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