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FRM Part I · FRM Exam Part I · The Building Blocks of Risk Management

In the risk management process, a firm has identified its exposures and measured them using VaR. It then decides to buy put options to reduce its downside exposure to an equity portfolio. Which step of the process does this decision represent?

This is risk mitigation, also called risk treatment, because the firm is taking an action, buying put options, to reduce its downside exposure after the risk was already identified and measured. Monitoring would be the later ongoing tracking of exposures and hedge effectiveness.

  1. ARisk identification
  2. BRisk measurement
  3. CRisk mitigation or treatmentCorrect
  4. DRisk monitoring

Explanation

Buying puts to cut downside exposure is an action that changes the risk profile, which is risk treatment or mitigation. Identification and measurement have already occurred, and monitoring is the ongoing tracking of exposures and the effectiveness of actions.

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