Howdy, Stranger!

It looks like you're new here. If you want to get involved, click one of these buttons!

CFA Events Calendar

View full calendar

CFA Events Calendar

View full calendar

Recommended Discussions

See how our partners can help you ace your CFA exams.

Risk Management-VAR

Please help to explain the answer

If the one-day value at risk of a portfolio is $50,000 at a 95 percent probability level, this means that we should expect that in one day out of:
A)20 days, the portfolio will decline by $50,000 or less.
B)95 days, the portfolio will lose $50,000.
C)20 days, the portfolio will decline by $50,000 or more.

Correct Answer: A
Reason given: This means that 5 out of 100 (or one out of 20) days, the value of the portfolio will experience a loss of $50,000 or more.

My understanding of VAR is that for the problem is, In a given day, there is 95% probability that we will lose a minimum of $50,000. How can we say that it is 1 out of 20 days? Please help. @alta12, @jwa, @Marc‌ , @Sophie‌

Comments

  • edited March 2014
    @RaviVooda - Is that the exact phrasing of the question? Is it saying there is a 95% probability that it will lose $50,000 or more on a given day? In which case there is a 5% probability that it will lose no than $50,000. I guess is is saying that on 19/20 days (0.95) or 95/100 days (0.95), the portfolio will lose more than $50,000 and therefore on 5/100 days (0.05) or 1/20 days (0.05) it will lose no more than $50,000. Seems an odd question to me, like the probabilities are the wrong way round.... I hate VAR.
  • MM12MM12 Amsterdam, the NetherlandsPosts: 58 Jr Portfolio Manager
    @RaviVooda‌ If this is the literal phrasing of the question and answer, then they made a mistake somewhere, because their reason given for choosing A would be correct for C - which is the answer I think is correct. Where did you find this question?

    VAR - Value at Risk is a metric that defines what your upper bound for losses are "within a certain confidence level". The way I interpret VAR of $50,000 at 95% probability level is in only 5% of the situations would you love $50,000 or more. As @jwa mentioned though, it could be that they have their probabilities reversed and this could mean that in 95% of the cases would you lose $50,000 or more, in which case answer A is correct.

    By the way, this is highly unlikely - I can't even think of any normal situation in which you would hold a portfolio where you EXPECT TO LOSE $50,000 OR MORE IN ALMOST ALL SITUATIONS. This hypothetical portfolio should have a huge upside if you'd be willing to have such a downside loss. I can only think of a portfolio of way-out-of-the-money options expiring in the near future. There is a huge probability of them being worth nothing, so value will go down to zero, but in the rare case that they become in the money, you can make a lot of profit.
  • BetankrichBetankrich MelbournePosts: 21 Associate
    Going by historical method, It is correct as it means that 5 out of 100 (or one out of 20) days, the value of the portfolio will experience a loss of $50,000 or more
  • @Jwa, my wording was wrong. It should say "In a given day, there is 5% probability that we will lose a minimum of $50,000"

    @MM12, the question is from schweser pro.

    @Betankrich, Considering we follow historical method, if we take a data of 30 days and when we calculate its monthly VAR, should we say "there is x% probability of losing $Y or more in one month period" or "there is x% probability of losing $Y or more in one day". ?
  • BetankrichBetankrich MelbournePosts: 21 Associate
    @raviVooda i believe "there is x% probability of losing $Y or more in one day" this would be correct
  • @Betankrich, I had this doubt, because we calculate VAR differently for day, month and year. I think I understood the question. In this question, we take historical data day wise, then sort and take data based on the probability. However I am doubtful of the wording that 1 out of 20 days.
  • BetankrichBetankrich MelbournePosts: 21 Associate
    @Ravivooda - Yes wording is ambiguous and possibly who will not find this to turn up on exam like above
Sign In or Register to comment.