Lara Fraser Case Scenario
Lara Fraser is the risk manager for Galaxy & Co., a large investment firm located in
Scotland. She recently hired a new employee, Stuart Wallace, to assist her with
enhancing the firm’s risk management process. Fraser asks Wallace to document the exposures to risk that have been identified through Galaxy & Co.’s current risk management process. As Wallace begins the project, Fraser responds to client questions and requests. Client A states:
“I am a new client and received my first investment portfolio statement. The statement specifies, “With 95 percent confidence, the VAR of the portfolio is $1 million for one month.” My portfolio holds long stock positions along with some option positions on
those stocks and I am concerned about the impact that low probability events may have on my portfolio performance. Can the VAR measure be adjusted to address this concern? In addition, please explain the primary limitation of VAR.”
Fraser responds with the following statements:
Statement 1: VAR quantifies potential losses in simple terms.
Statement 2: VAR often underestimates the magnitude and frequency of the worst returns.
Statement 3: VAR is a forward-looking measure that cannot be backtested against historical data.
Client B asks:
“I am preparing to make a VAR presentation to my Board of Directors. I am familiar with the analytical method of measuring VAR that Galaxy & Co. uses. Please describe other methods for estimating VAR and indicate a disadvantage of each.” Galaxy & Co.’s senior management wants to be confident that the firm is managing and measuring credit risk in an appropriate manner. They ask Fraser to provide a specific example of an investment instrument within the portfolio that may create credit risk.
Fraser chooses to illustrate the concept of credit risk with a swap example. A portion of the firm’s portfolio is invested in floating rate notes. Galaxy uses interest rate swaps to
manage the interest rate risk exposure of this investment. Specifically, the firm has entered into a one year pay variable receive fixed interest rate swap. The swap has a notional value of ￡1,000,000. The current market value of the swap to Galaxy is -￡47,000.
Fraser is confident that the techniques she employs to mitigate credit risk are comprehensive and follow industry best practice standards. She drafts a description of the techniques used at Galaxy and includes the following statement:
“In keeping with industry standards, our primary means of managing credit risk is requiring that our counterparties post collateral.” Meanwhile, Wallace drafts a memo to Fraser with some of his initial thoughts:
“As an investment firm that manages international and domestic fixed income and equity portfolios, Galaxy & Co. is exposed to both financial and non-financial risks. Each of these broad topics will be addressed in turn.” Wallace decides to initially add depth to the financial risks that the firm faces.
13. Fraser’s most appropriate response to Client A’s question regarding the possibility of adjusting the VAR measure is:
A. an increase in the confidence interval will increase the magnitude of the VAR measure.
B. the VAR measure will decrease if the time frame of measurement is increased.
C. for your portfolio, any confidence interval will provide essentially identical VAR information.
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 211-213 Study Session 14-40-e Interpret and compute value at risk (VAR) and explain its role in measuring overall and individual position market risk.
Increasing the confidence interval will increase VAR, which provides the client more information about less likely (low probability) events.
14. Fraser correctly identifies a limitation of VAR in:
A. Statement 1.
B. Statement 2.
C. Statement 3.
Answer: B
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 225-226 Study Session 14-40-g
Discuss the advantages and limitations of VAR and its extensions, including cash flow at risk, earnings at risk, and tail value at risk. VAR may be derived from erroneous assumptions and models leading to poor estimates of the size and frequency of bad outcomes.
15. Fraser drafts a number of possible responses to Client B. An appropriate response would include:
A. The Monte Carlo simulation method requires an assumption of normally distributed returns.
B. The historical method is nonparametric and does not allow the user to make assumptions about the probability distribution of returns.
C. The historical method relies completely on events of the past, and the probability distribution of the past may not hold in the future.
Answer: C
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 218-223 Study Session 14-40-g
Compare and contrast the analytical (variance-covariance), historical, and Monte Carlo methods for estimating VAR and discuss the advantages and disadvantages of each.
The historical method relies completely on events of the past, and whatever distribution prevailed in the past might not hold in the future. This is a disadvantage of the measure.
16. With respect to the plain vanilla interest rate swap, which of the following most accurately describes Galaxy’s exposure to credit risk?
A. No current credit risk
B. ￡47,000 at risk of loss
C. ￡953,000 at risk of loss
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 229-236 Study Session 14-40-i Evaluate the credit risk of an investment position, including forward contract, swap, and option positions.
The market value is negative, therefore Galaxy would lose nothing if the counterparty defaulted immediately.
17. Fraser’s statement regarding the management of credit risk is most likely:
A. correct.
B. incorrect, because the primary means of managing credit risk is periodic marking to market.
C. incorrect, because the primary means of managing credit risk is limiting the total exposure to a given counterparty.
Answer: C
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 243-247 Study Session 14-40-k Demonstrate the use of exposure limits, marking to market, collateral, netting arrangements, credit standards, and credit derivatives to manage credit risk.
A party will not engage in too many derivative transactions with one counterparty. The risk manager makes extensive use of quantitative credit exposure measures to guide them in the process to determine where and when to limit exposure.
18. As Wallace begins to add depth to the description of the initial source of risks present at Galaxy & Co., which of the following will he least likely include:
A. taxes.
B. liquidity.
C. interest rates.
Answer: A
“Risk Management,” Don M. Chance, Kenneth Grant, and John Marsland 2009 Modular Level III, Volume 5, pp. 199-202 Study Session 14-40-b Recommend and justify the risk exposures an analyst should report as part of an enterprise risk management system.
Taxes are a non-financial risk. | 
发表于 2009-7-2 15:16
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