Skip to content

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

A pension plan sponsor allocates its total active risk budget across several external managers and monitors each manager's tracking error against the plan's policy benchmark. Which statement best describes the purpose of a risk budget in this decentralised structure?

A risk budget allocates the total risk the sponsor is willing to tolerate, such as active risk or VaR, among managers or strategies, so risk is deployed where expected value added is highest. It is a risk allocation tool, not a fee cap or return guarantee.

  1. AIt sets the maximum total fees payable to each manager
  2. BIt allocates the plan's tolerated total risk, such as active risk, among managers so that risk is taken where expected value added is greatestCorrect
  3. CIt guarantees each manager the same return as its benchmark
  4. DIt requires every manager to hold identical positions to minimise tracking error

Explanation

A risk budget distributes the overall risk the sponsor is willing to bear (e.g., total tracking error or VaR) among managers or strategies, ideally in proportion to their expected contribution to value added. It is not a fee limit, a return guarantee or a requirement for identical positions.

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