CRA Risk Mitigation Strategies & Decision-Making 2 — Questions and Answers
Question 1: A company faces a 15% probability of a $2M loss from a supplier default. The annual insurance premium to cover this risk is $280,000. What is the expected value of the uninsured loss?
- $280,000
- $300,000 (Correct answer)
- $2,000,000
- $1,700,000
Correct answer: $300,000
Expected value = probability × impact = 0.15 × $2,000,000 = $300,000, which exceeds the $280,000 premium, making insurance cost-effective.
Question 2: Which decision-making framework specifically accounts for ambiguity by distinguishing between situations where probabilities are known versus unknown?
- Expected utility theory
- Knight's distinction between risk and uncertainty (Correct answer)
- Monte Carlo simulation
- Bayesian updating
Correct answer: Knight's distinction between risk and uncertainty
Frank Knight distinguished between risk (known probabilities) and uncertainty (unknown probabilities), which is foundational to modern risk decision-making frameworks.
Question 3: A risk manager implements a 'Swiss cheese model' for layered defenses. What is the PRIMARY purpose of this approach?
- Eliminate all residual risk
- Ensure that multiple independent barriers prevent a loss event (Correct answer)
- Transfer risk to a third party
- Reduce the probability of hazard identification
Correct answer: Ensure that multiple independent barriers prevent a loss event
The Swiss cheese model (Reason's model) uses multiple overlapping defensive layers so that when one layer has a 'hole,' other layers prevent the hazard from reaching an outcome.
Question 4: An organization's board requires that all strategic decisions exceeding $5M use a formal risk-adjusted return on capital (RAROC) analysis. This policy BEST reflects which principle?
- Risk avoidance at the enterprise level
- Embedding risk into capital allocation decisions (Correct answer)
- Transferring financial risk to shareholders
- Eliminating systemic risk across business units
Correct answer: Embedding risk into capital allocation decisions
RAROC integrates risk measurement directly into capital allocation, ensuring that returns are evaluated relative to the economic capital consumed, embedding risk discipline into strategy.
Question 5: During a crisis, a decision-maker relies heavily on the most recent dramatic failure rather than historical base rates. This cognitive error is known as:
- Anchoring bias
- Availability heuristic (Correct answer)
- Overconfidence bias
- Framing effect
Correct answer: Availability heuristic
The availability heuristic causes decision-makers to overweight recent or vivid events, distorting probability judgments away from objective base rates.
Question 6: A firm uses a 'risk appetite statement' that sets a maximum tolerable Value at Risk (VaR) of $10M at the 99% confidence level. A proposed project shows a 99th-percentile loss of $12M. The CORRECT action under this framework is to:
- Approve the project because expected returns exceed the loss
- Reject or restructure the project to bring VaR within appetite (Correct answer)
- Transfer the excess $2M risk via insurance
- Escalate to regulators for approval
Correct answer: Reject or restructure the project to bring VaR within appetite
The risk appetite statement is a binding constraint; a project exceeding the stated VaR limit must be rejected or redesigned to fit within approved tolerance.
Question 7: Which mitigation technique involves redesigning a business process to eliminate the source of risk entirely, rather than controlling or transferring it?
- Risk reduction
- Risk avoidance (Correct answer)
- Risk retention
- Risk sharing
Correct answer: Risk avoidance
Risk avoidance eliminates the activity or condition that creates the risk, removing exposure at the source rather than managing consequences.
CRA Risk Mitigation Strategies & Decision-Making 2
A company faces a 15% probability of a $2M loss from a supplier default.
The annual insurance premium to cover this risk is $280,000.
What is the expected value of the uninsured loss?