Baran

AIM 5: Explain how additional CFAR costs impact the capital budgeting decision.

 

1、Raymor Corporation has an expected cash flow of $150 million with volatility of $50 million. It is considering a project that costs $50 million and has a volatility of $20 million. The cash flow of the new project has a correlation of 0.70 with the cash flow of existing projects. The impact of the new project on cash flow at risk (CAR), calculated at the 95 percent confidence level, is closest to:

A) $30.52 million.
 
B) $36.28 million.
 
C) $98.37 million.
 
D) $25.69 million. 

Baran

The impact of the trade on the expected return of the portfolio is a(n):
A) increase of $80,000.
 
B) increase of $40,000.
 
C) decrease of $120,000.
 
D) increase of $160,000.

Baran

The correct answer is A

The impact on the expected return is (E(Ri)-E(Rj)) × Δw = (0.10 - 0.06) × (2/400) ×$400,000,000 = $80,000.

Baran

The impact of the trade on the VAR of the portfolio is a(n):
A) decrease of $2.20 million.
 
B) increase of $2.12 million.
 
C) decrease of $2.28 million.
 
D) increase of $2.70 million.

Baran

 The correct answer is B

 

Impact on VAR = -{(E(Ri)-E(Rj)) × Δw × W} + [(βip - βjp) × 1.65 × Vol(Rp) × Δw × W] = - {(0.10 -0.06) × (2/400) × 400} + [(2.22 - 1.11) × 1.65 × 0.60 × (2/400) × 400] = 2.12.

Baran

7、For a diversified portfolio, the VAR impact of a trade depends on the:

      I. betas of the traded assets.
     II. expected returns of traded assets.
    III. correlation between the returns of the risky assets.
    IV. size of the position in the traded assets.

A) I and II.
 
B) I, II, and IV.
 
C) I, II, and III.
 
D) II, III, and IV.
 

Baran

The correct answer is C

A trade increases VAR if the asset bought has a higher beta coefficient with respect to the portfolio than the asset sold, or if it has a lower expected return.

Baran

5、Suppose a trader has a portfolio of $20 million of his firm’s total portfolio of $500 million. The beta of the trader’s return with the return of the firm is 0.50. The contribution of the trader to the firm VAR of $100 million is:

A) $4 million.
 
B) $8 million.
 
C) $2 million.
 
D) $50 million.

Baran

The correct answer is C

Contribution of trader to VAR = wi × β × VAR(portfolio) = ($20 / $500)(0.5)$100 = $2 million.

Baran

6、 firm has a portfolio of traded assets worth $400 million with a VAR of $30 million. The standard deviation of the return on the portfolio is 0.60. The firm is considering the sale of a position worth $2 million in an asset that has an expected return of 6 percent and a covariance of return with the portfolio of 0.40. The position that would be added has an expected return of 10 percent and a covariance of return with the portfolio of 0.80. The VAR is based on a 95 percent confidence level.

The impact of the trade on the volatility of the portfolio is a(n):

A) increase of 0.0022.
 
B) increase of 0.0044.
 
C) decrease of 0.0080.
 
D) increase of 0.0033.