Module: | MODULE B: RISK MANAGEMENT
Q271: Consider the following statements regarding risk mitigation and risk transfer strategies, within the basic risk management framework:
1. Risk mitigation strictly involves reducing the probability of a downside event, by diversifying the portfolio across multiple uncorrelated sectors.
2. Risk transfer allows a bank to completely eliminate its initial credit exposure, by legally shifting the financial burden to a third party through insurance or securitization.
3. A bank can effectively mitigate its interest rate risk, by completely halting all new lending operations during periods of high macroeconomic volatility.
Which of the statements given above is/are correct?
2. Risk transfer allows a bank to completely eliminate its initial credit exposure, by legally shifting the financial burden to a third party through insurance or securitization.
3. A bank can effectively mitigate its interest rate risk, by completely halting all new lending operations during periods of high macroeconomic volatility.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: Risk mitigation involves strategic actions taken to reduce the severity or probability of a risk.
Diversification (spreading investments across uncorrelated asset classes or sectors) is a primary risk mitigation tool that minimizes concentration risk.
Statement 2 is correct: Risk transfer is a specific mitigation strategy where the bank legally passes the financial impact of a risk to a third party.
Common examples include buying credit insurance, using credit default swaps (CDS), or utilizing securitization to move assets off the balance sheet.
Statement 3 is incorrect: Completely halting all lending operations to avoid interest rate risk is risk avoidance, not risk mitigation.
Halting core operations destroys the bank's profitability and fundamental economic purpose.
True mitigation involves hedging the interest rate exposure using derivative products (like interest rate swaps) while continuing normal lending activities.
Diversification (spreading investments across uncorrelated asset classes or sectors) is a primary risk mitigation tool that minimizes concentration risk.
Statement 2 is correct: Risk transfer is a specific mitigation strategy where the bank legally passes the financial impact of a risk to a third party.
Common examples include buying credit insurance, using credit default swaps (CDS), or utilizing securitization to move assets off the balance sheet.
Statement 3 is incorrect: Completely halting all lending operations to avoid interest rate risk is risk avoidance, not risk mitigation.
Halting core operations destroys the bank's profitability and fundamental economic purpose.
True mitigation involves hedging the interest rate exposure using derivative products (like interest rate swaps) while continuing normal lending activities.