What does scenario analysis assess in financial risk management?

Scenario analysis in financial risk management is designed to assess potential future events and their impacts on an organization’s portfolio or financial position. This approach allows risk managers to evaluate how different scenarios—whether they are based on economic shifts, regulatory changes, or significant market movements—might affect financial outcomes.

By simulating various scenarios, including adverse and favorable conditions, organizations can gain insights into the range of possible outcomes and prepare for both best-case and worst-case scenarios. This proactive assessment enables more informed decision-making regarding risk mitigation strategies and capital allocation, ultimately enhancing the robustness of risk management practices.

Other choices, such as the legality of financial transactions or focusing only on extreme market conditions, do not capture the comprehensive and flexible nature of scenario analysis. Additionally, while historical performance can provide valuable context, it does not reflect the forward-looking approach that scenario analysis embraces. Thus, option A is the most representative of the primary function and purpose of scenario analysis in financial risk management.