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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A risk manager wants to incorporate climate-related risk into the firm's framework. Which statement correctly distinguishes physical risk from transition risk?

Physical risk arises from direct climate events such as floods or storms, while transition risk arises from policy, technology and market changes as the economy moves to low carbon. Carbon taxes are transition drivers, and both risks affect banks and insurers alike.

  1. APhysical risk stems from climate events such as floods; transition risk stems from policy, technology, or market shifts toward a low-carbon economyCorrect
  2. BPhysical risk stems from carbon taxes; transition risk stems from storms
  3. CBoth terms describe only litigation exposure
  4. DTransition risk applies only to insurers and physical risk only to banks

Explanation

Physical risk covers direct damage from acute or chronic climate events. Transition risk arises from the shift to a low-carbon economy through regulation, technology and preferences. The other options reverse or distort the definitions.

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