LO 69.2: Describe risk planning, including its objectives, effects, and the

LO 69.2: Describe risk planning, including its objectives, effects, and the participants in its development.
There are five risk planning objectives for any entity to consider. 1. Setting expected return and expected volatility goals.
Examples of an entitys goals could include specifying the acceptable amounts of VaR and tracking error for a given period of time. Scenario analysis could be employed to determine potential sources of failure in the plan as well as ways to respond should those sources occur.
2. Defining quantitative measures of success or failure.
Specific guidelines should be stated. For example, one could state an acceptable level of return on equity (ROE) or return on risk capital (RORC). This would help regulatory agencies assess the entitys success or failure from a risk management perspective.
3. Generalizing how risk capital will be utilized to meet the entitys objectives.
Objectives relating to return per unit of risk capital need to be defined. For example, the minimum acceptable RORC should be defined for each activity where risk is allocated from the budget. The correlations between the RORCs should also be considered within an entity-wide risk diversification context.
4. Defining the difference between events that cause ordinary damage versus serious
damage. Specific steps need to be formulated to counter any event that threatens the overall long- term existence of the entity, even if the likelihood of occurrence is remote. The choice between seeking external insurance (i.e., put options) versus self-insurance for downside portfolio risk has to be considered from a cost-benefit perspective, taking into account the potential severity of the losses.
Identifying mission critical resources inside and outside the entity and discussing what should be done in case those resources are jeopardized. Examples of such resources would include key employees and financing sources. Scenario analysis should be employed to assess the impact on those resources in both good and bad times. Specifically, adverse events often occur together with other adverse (and material) events.
In general, the risk planning process frequently requires the input and approval of the entitys owners and its management team. An effective plan requires very active input from the entitys highest level of management so as to ensure risk and return issues are addressed, understood, and communicated within the entity, to key stakeholders, and to regulatory agencies.
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Topic 69 Cross Reference to GARP Assigned Reading – Litterman, Chapter 17
Ris k Bu d g e t in g