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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

A portfolio manager holds a diversified equity portfolio and worries about a market-wide decline over the next quarter. Which risk-mitigation action most directly reduces the portfolio's exposure to systematic risk?

Selling stock index futures against the portfolio most directly reduces systematic risk, because the futures gain when the market falls and offset portfolio losses. Diversification within the same market only removes idiosyncratic risk and leaves market exposure largely unchanged.

  1. AAdding more stocks from the same market to the portfolio
  2. BSelling stock index futures against the portfolioCorrect
  3. CReplacing two holdings with two others in the same sector
  4. DRebalancing the portfolio to equal weights across existing holdings

Explanation

Systematic (market) risk cannot be removed by diversification within the same market. Short index futures offset market movements and therefore hedge that exposure. The other options only alter or reduce idiosyncratic risk, which a diversified portfolio already has little of.

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