FRM1 - The Building Blocks of Risk Management

Question 1

Explain the concept of risk and compare risk management with risk taking

Answer 1

Risk is the possibility that bad things happen

Risk management is reducing the impact felt by risk by a range of techniques

Question 2

Evaluate, compare, and apply tools and procedures used to measure and manage risk, including quantitative measures, qualitative risk assessment techniques, and enterprise risk management

Question 3

Distinguish between expected loss and unexpected loss and provide examples of each

Answer 3

Expected loss is the average loss a trader might expect to incur from a position

Unexpected loss is by how much losses exceed the expected level when they do

Question 4

Interpret the relationship between risk and reward and explain how conflicts of interest can impact risk management

Answer 4

Risk tends to increase with reward therefore its is on the risk manager to try to manage risk

Conflicts of interest can arise when traders understand risk management systems in place in a firm and therefore how to game it

Question 5

Describe and differentiate between key classes of risks, explain how each type of risk can arise, and assess the potential impact of each type of risk on an organisation

Answer 5

• market risk from exposure to market factors, can lead to losses if inappropriate hedging
• credit risk arising from borrowers not being able to repay their loans / couterparties
• liquidity risk being able to access funds to meet obligations
• op risk
• reputation risk

Question 6

Explain how risk factors can interact with each other and describe challenges in aggregating exposures

Answer 6

Important to break key risks down into fundamental risk factors and evaluate how they affect the wider business

Aggregating risks challenging but can be examined using VaR etc