When answering questions about whether something increases or decreases an entity’s ability to take risk… What is this relative to? Is it relative to 100% ability to take risk, so that any constaint on taking risk results in a decline of ability… or is it relative to a 0% ability to take risk, so that any lack of constaint is an increase in ability… or is it relative to the “average”… or what? The questions I’ve answered are so inconsistent in the guideline answers.
I wrote that in a very confusing way, so let me rephrase… When a question ask “Does X factor increase or decrease an entity’s ability to take risk?” … WHAT is the “increase” or “decrease” relative to?
It’s relative to some presumed average ability to take risk: some average time horizon, some average portfolio vs. annual expense ratio, some average liquidity requirement, and so on.
On the exam, they’ll have a conclusion they want you to reach: average, above average, or below average. If they want you to conclude that the ability is above average, they’ll give you several factors that point in that direction: long time horizon, large portfolio, low liquidity requirement; if they want you to conclude that the ability is below average, they’ll give you sevaral factors that point in that direction: short time horizon, small portfolio, high liquidity requirement.
Actually, it isn’t. A more well-thought-out reply – without the sarcasm – might have been helpful.
Example: younger workforce increases a pension plan’s ability to take risks - relative to absence of a ounger workforce i.e. if they had average age workforce instead.
Or: Low D/E decreases the company equity risk (vs high D/E = absence of low D/E).