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FRM Part I · FRM Exam Part I · The Governance of Risk Management

A trading desk's risk appetite sets a 99% one-day VaR limit of USD 10 million for the desk. The firm's overall board-approved risk capacity is far larger. The desk's VaR reaches USD 11.2 million for three consecutive days, yet no escalation occurs because the desk head argues the firm still has ample capacity. Which conclusion is most consistent with sound risk governance?

The breach should be escalated. Risk appetite, the chosen level of risk, is set below risk capacity, the maximum risk the firm could bear. Having spare capacity does not justify exceeding a desk limit, and limits should not be raised simply to match behavior.

  1. ANo action is needed because the firm's risk capacity has not been exceeded
  2. BThe limit breach should be escalated because risk appetite, not risk capacity, defines the acceptable level of risk the desk may takeCorrect
  3. CThe limit should be automatically raised to USD 11.2 million to reflect actual risk-taking
  4. DThe breach is acceptable because it lasted fewer than five days

Explanation

Risk appetite is the level of risk the firm chooses to take and is set below risk capacity, the maximum it could bear. Exceeding the desk limit is a breach requiring escalation regardless of remaining capacity. Raising limits to match behavior defeats the purpose of limits.

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