Reading 37: Risk Management －LOS g advantages, including

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 12: Risk Management
Reading 37: Risk Management
LOS g: Discuss the advantages and limitations of VAR and its extensions, including cash flow at risk, earnings at risk, and tail value at risk.

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With respect to value at risk (VAR), regulatory agencies:

A) in some industries require its computation and reporting.

B) dismiss it as a gimmick.

C) are studying it, but none have adopted its use.

D) have mandatory requirements in all financial industries.

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Answer and Explanation

The regulation in some industries address VAR, but many do not.

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

A) is included in the statistic.

B) is complete because the process is deterministic.

C) is one minus the probability level.

D) can only be ascertained after the fact.

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Answer and 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.

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Value at risk (VAR) is attractive because it:

A) is a measure of the most we can lose.

B) is a single and easily understood measure.

C) has a well-defined method for calculation.

D) all of these choices are correct.

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Answer and Explanation

VAR is an easily understood measure, but there are many ways to compute it. It is not a measure of the most that can be lost.

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Regarding the practical application of value at risk (VAR) for portfolio managers, which of the following statements is FALSE? VAR can:

A) be used to compare risk across asset classes.

B) not be used to set risk limits relative to a benchmark.

C) be used to set risk limits on an absolute level.

D) be used to identify the macroeconomic factors that have the greatest impact on overall portfolio performance.

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Answer and Explanation

VAR can be used to set risk limits for a portfolio either on an absolute level or on a relative basis versus a benchmark.

VAR can be used to set risk limits for a portfolio either on an absolute level or on a relative basis versus a benchmark.

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Which of the following statements describes the most unique and practical application of value at risk (VAR) for comparing risky assets? VAR can be used to compare risk:

A) across bond market sectors.

B) between small and large cap equities.

C) across asset classes such as bonds and stocks.

D) between different style equity portfolios.

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Answer and Explanation

VAR measures risk comparably across asset classes. Thus, the risk of a bond portfolio can be compared to that of an equity portfolio. This type of comparison is not very meaningful using other risk measures.

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Which of the following is NOT an appropriate application of VAR for portfolio managers?

A) Setting portfolio risk limits.

B) Risk evaluations across asset classes.

C) Peer group risk evaluation.

D) Identification of key portfolio risks.

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Answer and Explanation

No Answer Available

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As a risk measurement, value at risk may be superior to standard deviation because:

A) VAR may capture market participant's attitudes towards risk more completely.

B) the statistical properties of VAR are more widely understood.

C) the required data is available to all market participants.

D) most market participants calculate VAR in the same manner.

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Answer and Explanation

VAR, which measures downside risk, more completely captures the attitudes of many market participants towards risk.

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An investor hires a portfolio manager and stipulates a maximum value at risk for the portfolio. This is an example of the use of the value at risk framework to:

A) set risk limits.

B) measure performance.

C) build portfolios.

D) maximize returns.

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Answer and Explanation

The investor has used the value at risk framework to set risk limits for the portfolio.

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Which of the following is NOT a practical benefit of the value at risk framework?

A) Hedging.

B) Comparability across asset classes.

C) Setting of risk limits.

D) Identification of risk factors.

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Answer and Explanation

While value at risk may indicate risks that need to be hedged, it is not a hedging tool as such.