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FRM Part II · FRM Exam Part II · Risk Mitigation

A risk manager compares two mitigation options for a fraud risk with expected annual loss of USD 2.0 million. Option A costs USD 0.6 million per year and is expected to reduce the expected loss by 40%. Option B costs USD 0.3 million per year and is expected to reduce it by 20%. Based solely on net annual benefit (loss reduction minus cost), which is the better choice and by how much does it exceed the other?

Option A is better by USD 0.1 million. It reduces expected loss by USD 0.8 million at a cost of USD 0.6 million, netting USD 0.2 million, while Option B reduces loss by USD 0.4 million at a cost of USD 0.3 million, netting USD 0.1 million.

  1. AOption A, by USD 0.1 millionCorrect
  2. BOption B, by USD 0.1 million
  3. COption A, by USD 0.3 million
  4. DOption B, by USD 0.2 million

Explanation

Option A: 0.4 x 2.0 = 0.8 reduction minus 0.6 cost = 0.2 net. Option B: 0.2 x 2.0 = 0.4 minus 0.3 = 0.1 net. A exceeds B by 0.1 million. Choosing B because of its lower cost ignores the larger benefit of A.

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