Explanation:
A fundamental paradigm in finance is that return cannot be generated without the appropriate level of risk. The difficulty is in determining the risk/return tradeoffs. But to minimize conflicts, compensation schemes should be structured to incorporate benefits and costs. Focusing only on one, or overweighing one over another, will generate suboptimal outcomes for the firm.
(Book 1, Module 1.1, LO 1.d)
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Question 59
An investment manager oversees the equity, bond, and currency trading desks at Superior Traders. Although the traders have an incentive to generate profitable trading decisions, the manager wonders if they are taking an inordinate amount of risk. When formulating an appropriate compensation scheme for trading personnel, which of the following most appropriately addresses the manager's concerns?
A
Trading desk compensation should be structured to reward risk and punish returns.
B
Trading desk compensation should be structured to reward returns and punish risk.
C
Trading desk compensation should be structured to balance the tradeoff between returns and risk.
D
Trading desk compensation should be structured to enhance returns and risk.
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