Reading 37: Risk Management －LOS e individual, position, overall

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 12: Risk Management
Reading 37: Risk Management
LOS e: Interpret and compute value at risk (VAR) and explain its role in measuring overall and individual position market risk.

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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) delta.

B) the hedge ratio.

C) value at risk (VAR).

D) the coefficient of variation.

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Answer and Explanation

This is an often-used definition of VAR.

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

A) cannot exceed this amount.

B) is expected to be the average of the expected return of the portfolio and VAR.

C) may be much greater.

D) will have an inverse relationship with VAR.

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Answer and 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.

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If the one-day value at risk of a portfolio is $50,000 at a 95 percent 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 more.

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

C) 95 days, the portfolio will lose $50,000.

D) 95 days, the portfolio will increase by $50,000 or more.

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Answer and Explanation

This means that 5 out of 100 (or one out of 20) days, the value of the portfolio will experience a loss of $50,000 or more.