FinQuiz Level III 2018 – Item-sets Solution Reading 27: Risk Management Correct Answer: A The statement is correct.. All methods for calculating VAR suffer from the problem of needing
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CFA Level III Item-set - Solution
Study Session 14
June 2018
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Reading 27: Risk Management
Correct Answer: A
The statement is correct VAR fails to incorporate positive results into its risk profile, and as such, provides an incomplete picture of overall exposures (which includes all outcomes) Also, VAR can lead to a false sense of security by giving the impression that risk is properly measured and under control (this is true for any method used to calculate VAR)
Correct Answer: C
Statement 1 is incorrect VAR often underestimates the magnitude and frequency of the worst returns and this problem often derives from erroneous assumptions and models This inaccuracy can also result from the fact that some approaches to estimating VAR rely on a normal distribution which is not applicable in most cases
Statement 2 is incorrect All methods for calculating VAR suffer from the problem of needing to estimate inputs and the problem escalates as the number of assets in the portfolio gets larger Hence, the more the assets, the more difficult it is to estimate inputs, and the more assumptions one needs to make
Correct Answer: A
Comparing the number of violations of VAR thresholds, over a specific period of time in the past (e.g a year), with the figure implied by the user-selected probability level is part of a process known
as backtesting
Correct Answer: C
The VAR estimate is inaccurate A 5% daily VAR of $23,500 means that in a year, a loss of at least
$23,500 should be exceeded approximately 12.5 days Since there are around 20 violations, this means the model must be examined and appropriate adjustments must be made
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Correct Answer: B
A 5% weekly VAR of $10 million means that over a year (52 weeks) the portfolio will lose at least
$10 million or more approximately 2.6 weeks Since there were 3 violations, the actual results are of similar magnitude and hence the model seems accurate
However, the model may need to be tested over multiple time periods; such as over the recent most month, quarter or year, to further ensure its accuracy This does not necessarily mean that the model should be tested over longer time periods (one month corresponds to a short time period)
Correct Answer: A
An accurate VAR estimate can be extremely difficult to obtain for complex organizations, because identifying all the risks (which may be equal to thousands) to which they are exposed, and then predicting their impacts on the company’s value may be impossible or financially infeasible