CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 finquiz item set questions, study session 14, reading 27

FinQuiz Item-set ID: 7441 Questions 17442 through 67447 relate to Reading 27 Rupert Mindanao Case Scenario Rupert Mindanao is listing the tools that can be used to measure and manage r

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CFA Level III Item-set - Question

Study Session 14

June 2017

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FinQuiz Item-set ID: 7441

Questions 1(7442) through 6(7447) relate to Reading 27

Rupert Mindanao Case Scenario

Rupert Mindanao is listing the tools that can be used to measure and manage risk He knows that value at risk is one of the most common tools for quantifying a position’s risk, and has become the industry standard for risk assessment Mindanao however, is also aware of certain drawbacks and limitations of VAR During a discussion with his friend, Steve Flare, Mindanao made the following comment:

“VAR fails to incorporate positive results into its risk profile, and hence most often provides an incomplete picture of overall exposures Also VAR can sometimes lead to a false sense of

security.”

Flare made the following comments:

Statement 1: “Although VAR has several limitations, it has a number of advantages One of the

primary advantages of VAR is that it can almost always accurately estimate the magnitude and frequency of losses.”

Statement 2: “Another benefit of using VAR is that it can easily be applied to portfolios

composed of a large number of assets.”

Flare calculated that the 5% daily VAR of his portfolio is $23,500 He wants to determine

whether his model’s VAR estimate is accurate in predicting his portfolio’s risk Mindanao

advised that the best way to check the accuracy of the model is to compare the number of

violations of the VAR threshold, over a certain period of time, with the figure implied by the 5% probability level

Mark Irwin, a common friend of Mindanao and Flare, has been asked by his boss, Patricia

Turner, to calculate the 5% weekly VAR of an institutional fund composed primarily of options and derivatives Irwin used the Monte Carlo simulation method and estimated that the 5%

weekly VAR of the fund is $10 million Turner is not sure whether his method provided an accurate estimate, so he tests it for historical accuracy Turner determines that over the most recent year there were approximately three VAR exceptions (that is, losses greater than $10 million) Turner decides that the model is not accurate and needs adjustments

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FinQuiz Question ID: 7442

1 With regards to the drawbacks of VAR, Mindanao is most likely:

A correct

B incorrect, because VAR does not need to incorporate positive results since its a measure

of risk

C incorrect, because all approaches to estimating VAR do not lead to a false sense of

security

2 Flare is least accurate with respect to:

A statement 1 only

B statement 2 only

C both statements 1 and 2

3 The process described by Mindanao to determine the accuracy of the VAR estimate is best

known as:

A backtesting

B threshold violations test

C probability testing

4 If Flare determines that there are approximately 20 violations of the VAR threshold during

the recent year (250 trading days), the VAR estimate is most likely:

A accurate, because 20 violations per year is quite reasonable

B accurate, because the number of violations is close to what the model predicts

C inaccurate, because the number of violations exceeds that predicted by the model

5 Turner’s decision to adjust the model is most likely:

A correct, because the number of violations exceeds that predicted by the model

B incorrect, because the model is accurate

C incorrect, because the model should be tested over longer time periods

6 Which of the following is least likely an advantage of VAR?

A VAR is easy to calculate even for complex organizations

B VAR is a concept that is easily understood by senior management

C VAR can be used in the risk budgeting process

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