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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A risk manager notes that a business head manipulates reported performance because capital attributed to the unit changes whenever other units' positions change, even when the unit's own activities are unchanged. Which feature of the allocation method most likely causes this concern?

The cause is a diversification-based allocation method, where each unit's capital depends on how it correlates with the other units. When other units change positions, the allocation shifts even though the unit itself did nothing, weakening accountability and manager acceptance.

  1. AUse of stand-alone capital
  2. BUse of a fixed regulatory capital charge
  3. CReliance on a diversification-based method where one unit's allocation depends on the risk of other unitsCorrect
  4. DUse of expected loss rather than unexpected loss

Explanation

Under diversified methods such as incremental or marginal allocation, a unit's capital depends on its correlation with the rest of the firm. Changes elsewhere alter its allocation, which can make managers feel unfairly judged. Stand-alone and fixed regulatory charges do not depend on other units.

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