[ 2009 FRM Sample Exam ] Market risk measurement and management Q9 company, collect, management

Babul

 

9. The 10?Q report of ABC Bank states that the monthly Value at Risk of ABC Bank is USD 10 million at 95% confidence level. What is the proper interpretation(s) of this statement?

A. If we collect 100 monthly gain/loss data of ABC Bank, we will always see 5 months with losses larger than USD 10 million.

B. There is a 95% probability that the company will lose less than USD 10 million over a month.

C. There is a 5% probability that the company will gain less than USD 10 million each month.

D. There is a 5% probability that the company will lose less than USD 10 million over a month.

Babul

 

Correct answer is Bfficeffice" />

A is incorrect because it uses the word "always" as VaR is an expected value and actual gain/loss frequency often deviate from the expected value in practice.B is correct.  Per Jorion's definition, VAR summarizes the expected maximum losses (or worst loss) over a target horizon within a given confidence interval.  As a "confidence interval" represents a percentile point on the probability distribution, this can be phrased in probability terms.

C is incorrect since VaR is a measure of "maximum loss" not "minimum gain".

D is incorrect because the 95% confidence level is on the left tail of the probability distribution and there is only 5% losses greater then the VaR number.

Reference: Philippe Jorion, Value at Risk, 2nd Edition (ffice:smarttags" />New York: McGraw?Hill, 2001), Chapter 5.

Type of Question: Market Risk