hard · FRM Part 1 Foundations of Risk Management

Which response best reconciles the policy using the concept of comparative advantage in risk-bearing?

1. The objection is valid: any risk arising directly from a bank's core business activity is by definition a risk the bank has a comparative advantage in bearing, so the interest-rate gap should also be borne, not hedged.
2. Credit risk on the loans reflects the bank's informational comparative advantage and is compensated, whereas the interest-rate gap is an incidental exposure where the bank has no edge, so hedging it isolates the rewarded risk.
3. The policy is backwards: interest-rate risk trades in deep, liquid markets, so the bank actually holds the comparative advantage there, while illiquid credit risk is what should instead be transferred out to specialists.
4. Both risks should be hedged, because a sound enterprise risk appetite framework exists primarily to minimize total risk exposure across the balance sheet, and bearing any avoidable exposure violates the fundamental prudent-banker principle of caution.

Sign up free to see the explanation and track your rank →