Explanation

For a hedge fund applying risk management on a capital allocation basis, the most appropriate action is to subdivide its risk appetite among its business units (Option B).

Key Reasoning:

• Capital allocation-based risk management involves distributing the overall risk tolerance across different business units or strategies
• Option B directly addresses this by allocating risk appetite to various business units, which is fundamental to capital allocation decisions
• Option A (tracking error budgets) relates more to performance measurement against benchmarks rather than capital allocation
• Option C (protective options) is a reactive risk management strategy rather than a proactive capital allocation approach

This approach allows the fund to optimize risk-adjusted returns by allocating capital to units based on their risk profiles and expected returns.