Topic 1: Estimating Market Risk Measures Test ID: 8828811

Question #1 of 53 Question ID: 439303

Which of the common methods of computing value at risk relies on the assumption of normality?

✗ A) Monte Carlo simulation.

✓ B) Variance/covariance.

✗ C) Historical.

✗ D) Rounding estimation.

Explanation

The variance/covariance method relies on the assumption of normality.

Question #2 of 53 Question ID: 439336

An investor has 60 percent of his $500,000 portfolio in Value fund and the remaining in Growth fund. The correlation of returns of
the two funds is -0.20. Based on the information below, what is the portfolio's VAR at a 5 percent probability level?

Fund E(R) σ

Value 12% 14.0%

Growth 16% 20.0%

✗ A) $82,368.
✓ B) $17,635.
✗ C) $26,768.
✗ D) $49,824.

Explanation

Weight of Value Fund = W V=0.60; Weight of Growth Fund = W G = 0.40

Expected Portfolio return = E(RP) = 0.60(12)+0.40(16) = 13.60%

Portfolio Standard deviation =

σP = [(W V)2(σV)2+ (W G)2(σG)2+2(W V)(W G)rVGσVσG]0.5

= [(0.60)2(0.14)2+(0.40)2(0.20)2+2(0.60)(0.40)(-0.2)(0.14)(0.20)]0.5

= (0.010768)0.5

= 10.38%

VAR = Portfolio Value [ E(R) -zσ]

= 500,000[0.1360 - (1.65)(0.1038)] = -$17,635.

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Question #3 of 53 Question ID: 439334

If the one-day value at risk (VaR) of a portfolio is $50,000 at a 95% probability level, this means that we should expect that in
one day out of:

✗ A) 20 days, the portfolio will decline by $50,000 or less.

✓ B) 20 days, the portfolio will decline by $50,000 or more.
✗ C) 95 days, the portfolio will increase by $50,000 or more.
✗ D) 95 days, the portfolio will lose $50,000.

Explanation

A 95% one-day portfolio value at risk (VaR) of $50,000 means that in 5 out of 100 (or one out of 20) days, the value of the
portfolio will experience a loss of $50,000 or more.

Question #4 of 53 Question ID: 439330

An insurance company currently has a security portfolio with a market value of $243 million. The daily returns on the company's
portfolio are normally distributed with a standard deviation of 1.4%. Using the table below, determine which of the following
statements are TRUE.

zcritical

Alpha One-tailed Two-tailed

10% 1.28 1.65

2% 2.06 2.32

I. One-day VAR(1%) for the portfolio on a percentage basis is equal to 3.25%.

II. One-day VAR(10%) for the portfolio on a dollar basis is equal to $5.61 million.
III. One-day VAR(6%) > one-day VAR(10%).

✗ A) I only.
✗ B) II and III only.
✗ C) I, II, and III.
✓ D) I and III only.

Explanation

To find the appropriate zcritical value for the VAR(1%), use the two-tailed value from the table correspondnig to an alpha level of
2%. Under a two-tailed test, half the alpha probability lies in the left tail and half in the right tail. Thus the zcritical 2.32 is
appropriate for VAR(1%). For VAR(10%), the table gives the one-tail zcritical value of 1.28. Calculate the percent and dollar VAR
measures as follows:

VAR(1%) = z1% × σ

= 2.32 × 0.014

= 0.03248 ≈ 3.25%

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VAR(10%) = z10% × σ × portfolio value

= 1.28 × 0.014 × $243 million

= $4.35 million

Thus, Statement I is correct and Statement II is incorrect. For Statement III, recall that as the probability in the lower tail
decreases (i.e., from 10% to 6%), the VAR measure increases. Thus, Statement III is correct.

Question #5 of 53 Question ID: 439313

Super Hedge fund has $20 million in assets. The total return for the past 40 months is given below. What is the monthly value at
risk (VAR) of the portfolio at a 5 percent probability level?

Monthly Returns
-22.46% 9.26% -4.69% -20.66% -2.77% 1.17% -16.11% -6.73%

0.57% 12.56% -18.26% -32.81% 24.15% -34.26% -5.49% -19.76%

-34.75% -12.02% 32.74% -31.35% 13.68% -31.13% 7.07% -33.56%

-20.37% 30.27% 31.09% -3.26% -14.42% 4.75% 15.63% -11.57%

7.23% -20.77% -19.61% -2.42% -30.59% 28.83% -22.25% -10.26%

✗ A) $7,200,000.
✓ B) $6,852,000.
✗ C) $9,000,000.

✗ D) $16,725,000.

Explanation

Sorted monthly returns (from low to high, in columns) are as follows:

-34.75% -31.35% -22.25% -19.61% -11.57% -4.69% 0.57% 6.35%

-34.26% -31.13% -20.77% -18.26% -10.26% -3.26% 0.95% 7.07%

-33.56% -30.59% -20.66% -16.11% -6.73% -2.83% 1.17% 7.23%

-33.16% -23.08% -20.37% -14.42% -6.37% -2.77% 1.58% 8.35%

-32.81% -22.46% -19.76% -12.02% -5.49% -2.42% 4.75% 9.26%

The 5% lowest return is the 2nd value (2/40 = 0.05), which is -34.26%%
Therefore 5% VAR for the portfolio = 0.3426*$20,000,000 = $6,852,000

Question #6 of 53 Question ID: 439302

The accuracy of a value at risk (VAR) measure:

✗ A) is included in the statistic.

✓ B) can only be ascertained after the fact.
✗ C) is complete because the process is deterministic.

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 ✗ D) is one minus the probability level.

Explanation

This is a weakness of VAR. The reliability can only be known after some time has passed to see if the number and size of the
losses is congruent with the VAR measure.

Question #7 of 53 Question ID: 439818

The profit/loss distribution for Morozov Inc. (Morozov) is normally distributed with an annual mean of $20 million and a standard
deviation of $13 million. Which of the following amounts is closest to VAR at the 99% confidence level using a parametric
approach?

✓ A) $10.29 million.
✗ B) $5.48 million.
✗ C) $13.54 million.
✗ D) $1.45 million.

Explanation

VAR (1%) = −$20 million + $13 million × 2.33 = $10.29 million. Therefore, Morozov expects to lose at most $10.29 million over
the next year with 99% confidence. Equivalently, Morozov expects to lose more than $10.29 million with a 1% probability.

Question #8 of 53 Question ID: 439816

The 10-Q report of Global Bank states that the monthly VAR of ABC Bank is $10 million at a 95% confidence level. What is the
proper interpretation of this statement?

✓ A) There is a 95% probability that the bank will lose less than $10m over a month.
✗ B) If we collect 100 monthly gain/loss data of Global Bank, we will always see five months with losses
larger than $10m.
✗ C) There is a 5% probability that the bank will gain less than $10m each month.
✗ D) There is a 5% probability that the bank will lose less than $10m over a month.

Explanation

There is a 95% probability that the bank will lose less than $10m in a month. We could also say there is a 5% probability that we
will lose more than $10m in a month. "If we collect 100 monthly gain/loss data of Global Bank, we will always see five months with
losses larger than $10m" is not the correct interpretation of probability in that we cannot assume outcomes with certainty, instead
we need to assume probabilities.

Question #9 of 53 Question ID: 439298

You wish to estimate VAR using a local valuation method. Which of the following are methods you might use?
I. Historical simulation.
II. The delta-normal valuation method.
III. Monte Carlo simulation.

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IV. The grid Monte Carlo approach.

✗ A) I and II only.
✗ B) III and IV only.
✓ C) II only.
✗ D) I only.

Explanation

Local valuation methods measure portfolio risk by valuing the assets at one point in time, then making adjustments to relevant
risk factors that are expected to cause changes in the overall portfolio value. The delta-normal valuation method is an example of
a local valuation method.

Question #10 of 53 Question ID: 492008

Kiera Reed is a portfolio manager for BCG Investments. Reed manages a $140,000,000 portfolio consisting of 30 percent
European stocks and 70 percent U.S. stocks. If the VAR(1%) of the European stocks is 1.93 percent, or $810,600, the VAR(1%)
of U.S. stocks is 2.13 percent, or $2,087,400, and the correlation between European and U.S. stocks is 0.62, what is the
portfolio VAR(1%) on a percentage and dollar basis?

✓ A) 1.90% and $2.67 million.

✗ B) 2.07% and $2.90 million.
✗ C) 2.07% and $2.67 million.

✗ D) 1.90% and $2.90 million.

Explanation

VAR for the portfolio on a percentage and dollar basis is calculated as follows:

Question #11 of 53 Question ID: 439820

Which of the following statements regarding value at risk (VAR) and expected shortfall (ES) is least accurate?

✗ A) The calculated VAR amount is always reported as a negative value.

✓ B) The calculation of lognormal VAR and normal VAR will be similar when dealing with long-time periods.
✗ C) The ES provides an estimate of the tail loss by averaging the VARs for increasing confidence levels
in the tail.

✗ D) As the number of VAR observations increases, the ES will increase.

Explanation

The calculation of lognormal VAR and normal VAR will be similar when dealing with short time periods. VAR is always negative,

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but is typically reported as a positive value since the negative amount is implied. As the number of VAR observations increases,
the ES increases and approaches the theoretical true loss.

Question #12 of 53 Question ID: 439815

There are several different methods commonly used to compute value at risk (VAR). Which of the following statements best
describes historical VAR? It is:

✗ A) an analysis that looks for trends in VAR from period to period to predict future VAR.
✓ B) a method that computes VAR by assuming that losses in the future will occur with the same
frequency and magnitude as they have in the past.
✗ C) an analysis used by investors that compares current market risks to historical market risks.
✗ D) an analysis used by regulators that compares current market risks to historical market risks.

Explanation

This is the basic approach and assumption of historical VAR.

Question #13 of 53 Question ID: 439299

Annual volatility: σ = 20.0%

Annual risk-free rate = 6.0%

Exercise price (X) = 24

Time to maturity = 3 months

Stock price, S $21.00 $22.00 $23.00 $24.00 $24.75 $25.00

Value of call, C $0.13 $0.32 $0.64 $1.14 $1.62 $1.80

% Decrease in S −16.00% −12.00% −8.00% −4.00% −1.00%

% Decrease in C −92.83% −82.48% −64.15% −36.56% −9.91%

Delta (∆C% / ∆S%) 5.80 6.87 8.02 9.14 9.91

Suppose that the stock price is currently at $25.00 and the 3-month call option with an exercise price of $24.00 is $1.60. Using
the linear derivative VAR method and the information in the above table, what is a 5% VAR for the call option's weekly return?

✗ A) 43.4%.
✗ B) 50.7%.
✓ C) 45.3%.
✗ D) 21.6%.

Explanation

The weekly volatility is approximately equal to 2.77% a week (0.20 / √52). The 5% VAR for the stock price is equivalent to a 1.65
standard deviation move for a normal curve. The 5% VAR of the underlying stock is 0 − 2.77%(1.65) = −4.57%. A −1% change in

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the stock price results in a 9.91% change in the call option value, therefore, the delta = −0.0991 / −0.01 = 9.91. For small moves,
delta can be used to estimate the change in the derivative given the VAR for the underlying asset as follows: VARCall = ∆VARStock
= 9.91(4.57%) = 0.4529, or 45.29%. In words, the 5% VAR implies there is a 5% probability that the call option value will decline
by 45.29% or more over one week.

Question #14 of 53 Question ID: 439338

If a 1-day 95 percent VAR is $5 million, the 250-day 99 percent VAR level would be closest to:

✗ A) $21.00 million.
✓ B) $111.79 million.
✗ C) $55.89 million.
✗ D) $83.84 million.

Explanation

First it is necessary to adjust for confidence levels (2.326/1.645), then by days (√250). In this case, ($5 million)(2.326/1.645)
(√250) = $111.79 million.

Question #15 of 53 Question ID: 439317

A portfolio comprises 2 stocks: A and B. The correlation of returns of stocks A and B is 0.8. Based on the information below,
compute the portfolio's annual VAR at a 5 percent probability level.

Stock Value E(R) σ

A $75,000 12.0% 15.0%

B $25,000 10.8% 10.0%

✗ A) $13,300.
✗ B) $11,700.
✓ C) $10,295.

✗ D) $23,491.

Explanation

Weight of stock A = W A=0.75; Weight of stock B = W B = 0.25

Expected Portfolio return = E(RP) = 0.75(12)+0.25(10.8) = 11.70%

Portfolio Standard deviation =

sP = [(W A)2(sA)2+ (W B)2(sB)2+2(W A)(W B)rABsAsB]0.5

= [(0.75)2(0.15)2+(0.25)2(0.10)2+2(0.75)(0.25)(0.8)(0.15)(0.10)]0.5

= (0.0178)0.5

= 13.33%

VAR = Portfolio value [E(R)-zs]

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= 100,000[0.117 - (1.65)(0.1333)] = -$10,295

Question #16 of 53 Question ID: 439319

Which of the following statements about value at risk (VAR) is TRUE?

✗ A) VAR is not dependent on the choice of holding period.

✗ B) VAR decreases with longer holding periods.
✗ C) VAR is independent of probability level.
✓ D) VAR decreases with lower confidence level.

Explanation

VAR measures the amount of loss in the left tail of the distribution and increases with lower probability levels. Conversely VAR
decreases with lower confidence levels (which is 1 minus the probability level). VAR actually increases with increases in holding
period.

Question #17 of 53 Question ID: 439329

The difference between a Monte Carlo simulation and a historical simulation is that a historical simulation uses randomly selected
variables from past distributions, while a Monte Carlo simulation:

✓ A) uses a computer to generate random variables.

✗ B) projects variables based on a priori principles.

✗ C) uses randomly selected variables from future distributions.

✗ D) uses variables based on roulette odds.

Explanation

A Monte Carlo simulation uses a computer to generate random variables from specified distributions.

Question #18 of 53 Question ID: 439307

On December 31, 2006, Portfolio A had a market value of $2,520,000. The historical standard deviation of daily returns was
1.7%. Assuming that Portfolio A is normally distributed, calculate the daily VAR(2.5%) on a dollar basis and state its
interpretation. Daily VAR(2.5%) is equal to:

✗ A) $83,966, implying that daily portfolio losses will fall short of this amount 2.5% of the time.
✓ B) $83,966, implying that daily portfolio losses will only exceed this amount 2.5% of the time.

✗ C) $70,686, implying that daily portfolio losses will fall short of this amount 2.5% of the time.
✗ D) $70,686, implying that daily portfolio losses will only exceed this amount 2.5% of the time.

Explanation

VAR(2.5%)Percentage Basis = z2.5% × σ = 1.96(0.017) = 0.03332 = 3.332%.

VAR(2.5%)Dollar Basis = VAR(2.5%)Percentage Basis × portfolio value = 0.03332 × $2,520,000 $83,966.

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The appropriate interpretation is that on any given day, there is a 2.5% chance that the porfolio will experience a loss greater
than $83,996. Alternatively, we can state that there is a 97.5% chance that on any given day, the observed loss will be less than
$83,996.

Question #19 of 53 Question ID: 439339

For a $1,000,000 stock portfolio with an expected return of 12 percent and an annual standard deviation of 15 percent, what is
the VAR with 95 percent confidence level?

✗ A) $150,000.
✓ B) $127,500.
✗ C) $120,000.
✗ D) $247,500.

Explanation

VAR = Portfolio Value[E(R)-zσ]= 1,000,000[0.12 - (1.65)(0.15)] = -$127,500

Question #20 of 53 Question ID: 439326

The most important way in which the Monte Carlo approach to estimating operational VAR differs from the historical method and
variance-covariance method is:

✗ A) its heavy dependence on historical data.

✗ B) its inability to account for non-linear risk structures.
✗ C) its computational simplicity.

✓ D) it involves repeatedly shocking a model of risk data to produce a range of potential losses.

Explanation

The Monte Carlo approach uses simulation techniques, repeatedly shocking a model of loss data in order to produce a range of
potential losses. It is more computationally intensive than either the historical or variance-covariance approaches. The model
used can account for nonlinear risk structures and need not be limited by historical data.

Question #21 of 53 Question ID: 439300

Hugo Nelson is preparing a presentation on the attributes of value at risk. Which of Nelson's following statements is not correct?

✗ A) VAR was developed in order to more closely represent the economic capital necessary to
ensure commercial bank solvency.
✗ B) VAR can account for the diversified holdings of a financial institution, reducing capital requirements.

✓ C) VAR(1%) can be interpreted as the number of days that a loss in portfolio value will exceed 1%.
✗ D) VAR(10%) = $0 indicates a positive dollar return is likely to occur on 90 out of 100 days.

Explanation

VAR is defined as the dollar or percentage loss in portfolio value that will be exceeded only X% of the time. VAR(10%) = $0

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indicates that there is a 10% probability that on any given day the dollar loss will be greater than $0. Alternatively, we can say
there is a 90% probability that on any given day the dollar gain will be greater than $0. VAR was developed by commercial banks
to provide a more accurate measure of their economic capital requirements, taking into account the effects of diversification.

Question #22 of 53 Question ID: 439331

When would a Monte Carlo simulation be preferable to a historical simulation?

✓ A) There is only a small amount of historical data.

✗ B) Insufficient computer capacity.
✗ C) Historical data does not produce favorable results.
✗ D) A large amount of historical data is available.

Explanation

Historical simulation is most applicable if there is a large sample of past returns to draw from. The computer capacity necessary
for each is about the same, and certainly the occurrence of unfavorable results is no reason to reject historical simulation.

Question #23 of 53 Question ID: 439341

The price value of a basis point (PVBP) of a $20 million bond portfolio is $25,000. Interest rate changes over the next one year
are summarized below:

Change in Interest rates Probability

>+2.50% 1%

+2.00-2.49% 4%

0.00-1.99% 50%

-0.99-0.00% 40%

<-1.00% 5%

Compute VAR for the bond portfolio at 95 percent confidence level.

✗ A) $12,500.
✓ B) $5,000,000.
✗ C) $2,500,000.
✗ D) $2,750,000.

Explanation

At 5% probability level change in interest rates is 2.00% or higher.

Change in Portfolio value for 200 bps change in interest rate = 200*$25,000
VAR = $5,000,000.

Question #24 of 53 Question ID: 439297

A large bank currently has a security portfolio with a market value of $145 million. The daily returns on the bank's portfolio are

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normally distributed with 80% of the distribution lying within 1.28 standard deviations above and below the mean and 90% of the
distribution lying within 1.65 standard deviations above and below the mean. Assuming the standard deviation of the bank's
portfolio returns is 1.2%, calculate the VAR(5%) on a one-day basis.

✓ A) $2.87 million.
✗ B) $2.23 million.
✗ C) cannot be determined from information given.
✗ D) $2.04 million.

Explanation

VAR(5%) = z5% × σ × portfolio value

= 1.65 × 0.012 × $145 million
= $2.871 million

Question #25 of 53 Question ID: 439320

The Westover Fund is a portfolio consisting of 42 percent fixed income investments and 58 percent equity investments. The
manager of the Westover Fund recently estimated that the annual VAR(5 percent), assuming a 250-day year, for the entire
portfolio was $1,367,000 based on the portfolio's market value of $12,428,000 and a correlation coefficient between stocks and
bonds of zero. If the annual loss in the equity position is only expected to exceed $1,153,000 5 percent of the time, then the daily
expected loss in the bond position that will be exceeded 5 percent of the time is closest to:

✗ A) $21,163.
✗ B) $55,171.
✓ C) $46,445.

✗ D) $72,623.

Explanation

Begin by using the formula for dollar portfolio VAR to compute the annual VAR(5%) for the bond position:
VAR2portfolio = VAR2Stocks + VAR2Bonds + 2VARStocksVARBonds ρStocks, Bonds
(1,367,000)2 = (1,153,000)2 + VAR2Bonds + 2(1,153,000)VARBonds(0)
VARBonds = [(1,367,000)2 - (1,153,000)2]0.5 = 734,357

Next convert the annual $VARBonds to daily $VARBonds:

734,357 / (250)0.5 = 46,445

Question #26 of 53 Question ID: 439817

In the presence of fat tails in the distribution of returns for a linear portfolio, VAR based on the delta-normal method would:

✓ A) underestimate the true VAR.

✗ B) be the same as the true VAR.
✗ C) overestimate the true VAR.
✗ D) cannot be determined from the information provided.

Explanation

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The VAR would be underestimated because of the greater frequency of losses in the tails of the distribution.

Question #27 of 53 Question ID: 439301

A portfolio manager determines that his portfolio has an expected return of $20,000 and a standard deviation of $45,000. Given a 95
percent confidence level, what is the portfolio's VAR?

✗ A) $43,500.
✗ B) $74,250.

✗ C) $94,250.

✓ D) $54,250.

Explanation

The expected outcome is $20,000. Given the standard deviation of $45,000 and a z-score of 1.65 (95% confidence level for a one-tailed
test), the VAR is -54,250 [=20,000 - 1.65 (45,000)].

Question #28 of 53 Question ID: 439312

Tim Jones is evaluating two mutual funds for an investment of $100,000. Mutual fund A has $20,000,000 in assets, an annual
expected return of 14 percent, and an annual standard deviation of 19 percent. Mutual fund B has $8,000,000 in assets, an
annual expected return of 12 percent, and an annual standard deviation of 16.5 percent. What is the daily value at risk (VAR) of
Jones' portfolio at a 5 percent probability if he invests his money in mutual fund A?

✓ A) $1,924.
✗ B) $1,668.
✗ C) $13,344.
✗ D) $38,480.

Explanation

Daily standard deviation for mutual fund A = 0.19/√250= 0.012

Daily return = 0.14/250 = 0.00056
VAR = Portfolio Value [E(R)-zσ]
= 100,000[0.00056 - (1.65)(0.012)] = -$1,924.

Question #29 of 53 Question ID: 440258

The expected loss given that the loss has exceeded the VAR is best described as the:

✓ A) expected shortfall.

✗ B) Poisson parameter.
✗ C) economic capital.
✗ D) unexpected loss.

Explanation

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Expected shortfall is essentially an average or expected value of all losses greater than the VAR. An expression for this is: E[LP |
LP > VAR].

Questions #30-31 of 53

Communities Bank has a $17 million par position in a bond with the following characteristics:

The bond is a 7-year, zero-coupon bond.

The market value is $12,358,674.

The bond is trading at a yield to maturity of 4.6%.

The historical mean change in daily yield is 0.0%.

The standard deviation of the position is 1%.

Question #30 of 53 Question ID: 439344

The one-day VAR for this bond at the 95% confidence level is closest to:

✗ A) $260,654.
✓ B) $203,918.
✗ C) $339,487.

✗ D) $105,257.

Explanation

VAR is the market value of the position times the price volatility of the position times the confidence level, which in this case
equals ($12,358,674) × (0.01) × (1.65) = $203,918.

Question #31 of 53 Question ID: 439345

The 10-day VAR on this bond is closest to:

✗ A) $487,698.
✗ B) $736,487.
✗ C) $866,111.
✓ D) $644,845

Explanation

The VAR is calculated as the daily earnings at risk times the square root of days desired, which is 10. The calculation generates
($203,918)(√10) = $644,845.

Question #32 of 53 Question ID: 439322

A global portfolio is comprised of European and Emerging market equities. The correlation of returns for the two sectors is 0.3.
Based on the information below, what is the portfolio's annual value at risk (VAR) at a 5 percent probability level?

Stock Value E(R) σ

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 European $800,000 9.0% 15.0%
Emerging $200,000 18.0% 25.0%

✓ A) $128,280.
✗ B) $110,700.
✗ C) $230,491.
✗ D) $130,300.

Explanation

Weight of European equities = W A=0.80; Weight of Emerging = W B = 0.20

Expected Portfolio return = E(RP) = 0.8(9)+0.2(18) = 10.80%

Portfolio Standard deviation =

σP = [(W A)2(σA)2+ (W B)2(σB)2+2(W A)(W B)rABσAσB]0.5

= [(0.8)2(0.15)2+(0.2)2(0.25)2+2(0.8)(0.2)(0.3)(0.15)(0.25)]0.5

= (0.0205)0.5

= 14.32%

VAR = Portfolio Value[E(R) - zσ]

= 1,000,000[0.108 - (1.65)(0.1432)] = -$128,280.

Question #33 of 53 Question ID: 439311

If the expected change in a fixed income portfolio is $520,000 and the standard deviation of the estimated change in the portfolio
is $2,275,500, the 95 percent value-at-risk (VAR) for this portfolio is closest to:

✗ A) $855,400.00.

✗ B) $4,598,597.50.
✓ C) $3,223,197.50.
✗ D) $3,743,197.50.

Explanation

VAR for this portfolio would be -[$520,000 - 1.645($2,275,500)] = $3,223,197.50.

Question #34 of 53 Question ID: 439309

Many analysts prefer to use Monte Carlo simulation rather than historical simulation because:

✗ A) past data is often proprietary and difficult to obtain.

✓ B) past distributions cannot address changes in correlations or events that have not happened before.

✗ C) it is much easier to generate the required variables.

✗ D) computers can manipulate theoretical data much more quickly than historical data.

Explanation

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While the past is often a good predictor of the future, simulations based on past distributions are limited to reflecting changes and events
that actually occurred. Monte Carlo simulation can be used to model based on parameters that are not limited to past experience.

Question #35 of 53 Question ID: 439306

Which of the following statements about value at risk (VAR) is TRUE?

✗ A) VAR decreases with longer holding periods.

✗ B) VAR is not dependent on the choice of holding period.
✗ C) VAR is independent of probability level.
✓ D) VAR increases with lower signifiance levels.

Explanation

VAR measures the amount of loss in the left tail of the distribution and increases with lower signifiance levels. VAR actually
increases with increases in holding period.

Question #36 of 53 Question ID: 439308

The VaR measure obtained from simulating data based on assumptions concerning the return distributions is called:

✗ A) Kurtotic VaR.
✗ B) Prospective VaR.
✓ C) Monte Carlo VaR.

✗ D) Stochastic VaR.

Explanation

Monte Carlo VaR uses data generated from a simulation procedure.

Question #37 of 53 Question ID: 439315

If a 10-day VAR is $15,000,000, the 250-day VAR, assuming no change in confidence level, would be:

✗ A) $7,500,000.
✗ B) $23,700,000.
✓ C) $75,000,000.
✗ D) $237,000,000.

Explanation

Just back out the 1-day VAR by dividing by the square root of 10 and then multiply by the square root of 250 to get the 250-day
VAR.

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Question #38 of 53 Question ID: 439323

The minimum amount of money that one could expect to lose with a given probability over a specific period of time is the
definition of:

✗ A) the hedge ratio.

✗ B) delta.
✗ C) the coefficient of variation.
✓ D) value at risk (VAR).

Explanation

This is an often-used definition of VAR.

Question #39 of 53 Question ID: 439314

A $2 million balanced portfolio is comprised of 40 percent stocks and 60 percent intermediate bonds. For the next year, the
expected return on the stock component is 9 percent and the expected return on the bond component is 6 percent. The standard
deviation of the stock component is 18 percent and the standard deviation of the bond component is 8 percent. What is the
annual VAR for the portfolio at a 1 percent probability level if the correlation between the stock and the bond component is 0.25?

✗ A) $126,768.
✗ B) $152,250.
✗ C) $149,500.
✓ D) $303,360.

Explanation

Weight of Stock = W S=0.40; Weight of Bonds = W B = 0.60

Expected Portfolio return = E(RP) = 0.40(9)+0.60(6) = 7.20%

Portfolio Standard deviation =

σP = [(W S)2(σS)2+ (W B)2(σB)2+2(W S)(W B)rSBσSσB]0.5

= [(0.40)2(0.18)2+(0.60)2(0.08)2+2(0.40)(0.60)(0.25)(0.18)(0.08)]0.5

= (0.009216)0.5

= 9.6%

VAR = Portfolio Value [ E(R) -zσ]

= 2,000,000[0.072 - (2.33)(0.096)] = $303,360.

Question #40 of 53 Question ID: 439340

One advantage of the Monte Carlo simulation approach over the historical method when calculating VAR is the simulation
approach:

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 ✗ A) makes better use of computing power.
✓ B) incorporates flexibility in modeling price paths.
✗ C) takes advantage of the normal distribution.
✗ D) equates past performance to future results.

Explanation

The Monte Carlo approach allows for whatever relationships the VAR modeler would like to take into account. It is the most
flexible method for generating VAR.

Question #41 of 53 Question ID: 439335

Portfolio A has total assets of $14 million and an expected return of 12.50 percent. Historical VAR of the portfolio at 5 percent
probability level is $2,400,000. What is the portfolio's standard deviation?

✗ A) 14.65%.
✗ B) 15.75%.
✓ C) 17.97%.
✗ D) 12.50%.

Explanation

VAR = Portfolio Value [E(R)-zσ]

-2,400,000 = 14,000,000[0.125 - (1.65)(X)]
-2,400,000 = 1,750,000 - 23,100,000(X)
X = 17.97%.
Note that VAR value is always negative.

Question #42 of 53 Question ID: 439321

Derivation Inc. has a portfolio of $100 MM. The expected return over one year is 6 percent, with a standard deviation of 8
percent. What is the VAR for this portfolio at the 99 percent confidence level?

✓ A) $12.6 MM.
✗ B) $2.0 MM.
✗ C) $7.2 MM.
✗ D) $12.1 MM.

Explanation

VAR = $100 MM [0.06 - (2.326)(0.08)] = $12.608 MM

Question #43 of 53 Question ID: 439328

A portfolio comprises 2 stocks: A and B. The correlation of returns of stocks A and B is 0.4. Based on the information below,
what is the portfolio's value-at-risk (VAR) at a 5 percent probability level?

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 Stock Value E(R) σ

A $85,000 15.0% 18.0%

B $15,000 12.0% 10.0%

✗ A) $23,491.
✓ B) $11,784.
✗ C) $1,410.
✗ D) $13,300.

Explanation

Weight of stock A = W A= 0.85; Weight of stock B = W B = 0.15

Expected Portfolio return = E(RP) = 0.85(15)+0.15(12) = 14.55%

Portfolio Standard deviation =

sP = [(W A)2(sA)2+ (W B)2(sB)2+2(W A)(W B)rABsAsB]0.5

= [(0.85)2(0.18)2+(0.15)2(0.10)2+2(0.85)(0.15)(0.4)(0.18)(0.10)]0.5

= (0.02547)0.5

= 15.96%

VAR = Portfolio value [E(R) - zs]

= 100,000[0.1455 - (1.65)(0.1596)] = -$11,784

Question #44 of 53 Question ID: 439819

Conditional VaR (i.e., expected shortfall) is best described as the:

✓ A) average loss given that losses exceed the VaR.

✗ B) loss conditional on specific economic conditions.
✗ C) loss conditional on specific market conditions.
✗ D) loss if new assets are added to the portfolio.

Explanation

The Conditional VaR is the average of the losses that exceed the pre-specified worst case return, which for example may be the
pre-specified VaR.

Question #45 of 53 Question ID: 439324

Alto Steel's pension plan has $250 million in assets with an expected return of 12 percent. The last thirty monthly returns are
given below.
What is the 10 percent monthly probability VAR for Alto's pension plan?

21.84% -21.50% 31.76% 8.88% 2.54% 17.44%

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 6.97% 10.00% 2.71% 35.66% 31.07% 18.56%

9.82% -7.94% -0.78% 12.57% 11.77% 8.47%

2.99% 14.35% 14.20% 9.81% 11.03% 22.25%

9.68% 19.55% 8.53% 39.45% 36.15% 10.97%

✗ A) $1,200,000.
✗ B) $3,000,000.
✓ C) $1,950,000.
✗ D) $36,125,850.

Explanation

Sorted monthly returns (from low to high, in columns) are as follows:

-21.50% 2.99% 9.68% 11.03% 17.44% 31.07%

-7.94% 6.97% 9.81% 11.77% 18.56% 31.76%

-0.78% 8.47% 9.82% 12.57% 19.55% 35.66%

2.54% 8.53% 10.00% 14.20% 21.84% 36.15%

2.71% 8.88% 10.97% 14.35% 22.25% 39.45%

The 10% lowest return is the 3rd value (3/30 = 0.10), which is -0.78%
Therefore 10% VAR for the portfolio = 0.0078*250,000,000 = 1,950,000

Question #46 of 53 Question ID: 439337

Annual volatility: σ = 20.0%

Annual risk-free rate = 6.0%

Exercise price (X) = 24

Time to maturity = 3 months

Stock price, S $21.00 $22.00 $23.00 $24.00 $24.75 $25.00

Value of call, C $0.13 $0.32 $0.64 $1.14 $1.62 $1.80

% Decrease in S −16.00% −12.00% −8.00% −4.00% −1.00%

% Decrease in C −92.83% −82.48% −64.15% −36.56% −9.91%

Delta (∆C% / ∆S%) 5.80 6.87 8.02 9.14 9.91

Alton Richard is a risk manager for a financial services conglomerate. Richard generally calculates the VAR of the company's
equity portfolio on a daily basis, but has been asked to estimate the VAR on a weekly basis assuming five trading days in a
week. If the equity portfolio has a daily standard deviation of returns equal to 0.65% and the portfolio value is $2 million, the
weekly dollar VAR (5%) is closest to:

✗ A) $29,100.

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 ✓ B) $47,964.
✗ C) $107,250.
✗ D) $21,450.

Explanation

The weekly VAR is 2 million × 1.65 × 0.0065 × √5 = $47,964.

Question #47 of 53 Question ID: 439305

Which of the following statements comparing Monte Carlo VaR and historical VaR is most accurate?

✗ A) Both are parametric approaches, but historical VaR uses a regression on past data while
Monte Carlo VaR uses Kalman filtering to create forward looking VaR estimates.

✓ B) Both compute VaR from percentiles from a given set of observed returns, but historical VaR uses
realized returns and Monte Carlo VaR uses hypothetical returns.

✗ C) Both compute VaR from percentiles from a given set of observed returns, but Monte Carlo VaR uses
realized returns and historical VaR uses hypothetical returns.

✗ D) Both are parametric approaches, but Monte Carlo VaR uses fewer inputs into the model than
historical VaR.

Explanation

Historical VaR uses historical realized returns, and Monte Carlo VaR uses returns generated from a hypothetical model, which
requires a significant number of inputs. Neither historical nor Monte Carlo VaR is a parametric approach.

Question #48 of 53 Question ID: 439325

The price value of a basis point (PVBP) of a bond portfolio is $45,000. Expected changes in interest rates over the next year are
summarized below:

Change in Interest rates Probability

>+1.50% 1%
+1.00-1.49% 29%
0.00-0.99% 20%
-0.99-0.00% 45%
<-1.00% 5%

What is the value at risk (VAR) for the bond portfolio at a 99 percent confidence level?

✓ A) $6,750,000.
✗ B) $2,250,000.
✗ C) $4,500,000.
✗ D) $7,850,500.

Explanation

At 1% probability level change in interest rates is 1.50% or higher.

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Change in Portfolio value for a 150 bps change in rates = 150*45000 = 6,750,000
VAR = 6,750,000.

Question #49 of 53 Question ID: 439310

A hedge fund portfolio has an expected return of 0.1 percent per day and a 5 percent probability 1-day value at risk (VAR) of
$909. Which of the following statement is the best descriptor of this information?

✗ A) The maximum daily loss on the portfolio is $909.

✓ B) The minimum loss for the worst 5% of the days is $909.
✗ C) The minimum daily loss on the portfolio is $909.
✗ D) The portfolio will earn more than $909 only 5% of the time.

Explanation

By definition, VAR is the minimum loss for the worst 5% of the days or the maximum 1-day loss 95% of days. A minimum or
maximum daily loss on the portfolio of $909 does not incorporate the alpha (probability). Alternatively, VAR can be stated in terms
of confidence, e.g. in this case you could say you are 95% confident the one-day VAR will not exceed $909.

Question #50 of 53 Question ID: 439318

Which of the following statements about value at risk (VAR) is TRUE?

✗ A) VAR decreases with lower probability levels.

✗ B) VAR is not dependent on the choice of holding period.
✓ C) VAR increases with longer holding periods.

✗ D) VAR is independent of probability level.

Explanation

VAR measures the amount of loss in the left tail of the distribution. It increases with lower probability levels and increases in
holding period.

Question #51 of 53 Question ID: 439327

A portfolio manager is constructing a portfolio of stocks and corporate bonds. The portfolio manager has estimated that stocks
and corporate bond returns have daily standard deviations of 1.8% and 1.1%, respectively, and estimates a correlation
coefficient of returns of 0.43. If the portfolio manager plans to allocate 35% of the portfolio to corporate bonds and the rest to
stocks, what is the daily portfolio VAR (2.5%) on a percentage basis?

✗ A) 3.05%.

✗ B) 2.57%.
✓ C) 2.71%.
✗ D) 2.27%.

Explanation

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First, calculate the standard deviation of the portfolio:

[0.652(0.0182) + 0.352(0.0112) + 2(0.35)(0.65)(0.018)(0.011)(0.43)]0.5 = 1.38%

Next calculate the portfolio VAR:

z2.5% × σ = 1.96(0.0138) = 2.71%

Question #52 of 53 Question ID: 439333

Value at risk (VAR) is a benchmark associated with a given probability. The actual loss:

✗ A) is expected to be the average of the expected return of the portfolio and VAR.
✗ B) will have an inverse relationship with VAR.
✓ C) may be much greater.
✗ D) cannot exceed this amount.

Explanation

VAR is a benchmark that gives an estimate of what magnitude of loss would not be unusual. The actual loss for any given time
period can be much greater.

Question #53 of 53 Question ID: 439304

Which value at risk methodology is most subject to model risk?

✗ A) Parametric.
✗ B) Variance/covariance.

✗ C) Historical.

✓ D) Monte Carlo simulation.

Explanation

Monte Carlo simulation is subject to model risk.

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