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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

An asset manager's board sets a risk appetite that annual losses should not exceed 8% of capital at a 95% confidence level. The firm's capital is USD 500 million and the one-year portfolio VaR at 95% is USD 46 million. Which conclusion is correct?

The portfolio breaches appetite. The limit is 8% of USD 500 million, or USD 40 million, and the one-year 95% VaR of USD 46 million exceeds it, so risk must be reduced or the breach escalated.

  1. AThe portfolio breaches appetite because 46 million exceeds 40 millionCorrect
  2. BThe portfolio is within appetite because 46 million is below 50 million
  3. CThe portfolio breaches appetite only if VaR is measured at 99%
  4. DAppetite cannot be compared with VaR because they use different units

Explanation

Appetite threshold = 8% x 500 = USD 40 million. VaR of 46 million exceeds it, so the portfolio is outside appetite. The 50 million comparison wrongly uses 10% of capital.

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