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CFA Level I · CFA Level I Exam · Introduction to Risk Management

A pension fund's board sets a risk budget that allocates the total acceptable risk across asset classes and managers. The most likely benefit of the risk budgeting process is that it:

Risk budgeting most likely aligns risk-taking with the fund's objectives and tolerance by allocating total acceptable risk to where it is expected to be rewarded. It does not guarantee limits are never breached and still depends on portfolio-level risk measurement.

  1. Aguarantees that realized losses will remain below the tolerance limit
  2. Beliminates the need to measure risk at the portfolio level
  3. Caligns the use of risk with return objectives and tolerance by assigning it where it is expected to be rewardedCorrect

Explanation

Risk budgeting allocates acceptable total risk to the sources where it is expected to add the most return, linking tolerance to objectives. It cannot guarantee losses stay below a limit, and portfolio-level measurement is still required to set the total budget.

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