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

Which statement best distinguishes risk appetite from risk capacity in an ERM framework?

Risk appetite is the level of risk a firm chooses to take to pursue its objectives, and it should lie within risk capacity, which is the maximum risk the firm can bear given capital, liquidity and regulatory constraints. Capacity is the ceiling; appetite is the chosen amount below it.

  1. ARisk appetite is the maximum risk a firm can bear before breaching regulatory or financial constraints, while capacity is the amount it chooses to take
  2. BRisk appetite is the amount of risk a firm chooses to take to pursue its objectives, and it should sit within the firm's risk capacityCorrect
  3. CRisk appetite and risk capacity are identical, differing only in whether they are quantitative
  4. DRisk appetite is set by regulators, while capacity is set by the board

Explanation

Risk capacity is the maximum risk the firm can absorb given capital, liquidity and regulatory constraints. Risk appetite is the level it chooses to take and must be within capacity. The first option reverses the definitions.

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