Reading 27 Risk Management FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session 14 June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading 27 Risk Management FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 27: Risk Management Question ID: 7442 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) Question ID: 7443 Correct Answer: C Statement 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 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 Question ID: 7444 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 Question ID: 7445 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 FinQuiz.com © 2018 - All rights reserved Reading 27 Risk Management FinQuiz.com Question ID: 7446 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 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) Question ID: 7447 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 FinQuiz.com © 2018 - All rights reserved .. .Reading 27 Risk Management FinQuiz. com FinQuiz Level III 2018 – Item- sets Solution Reading 27: Risk Management Question ID: 7442 Correct Answer:... model must be examined and appropriate adjustments must be made FinQuiz. com © 2018 - All rights reserved Reading 27 Risk Management FinQuiz. com Question ID: 7446 Correct Answer: B A 5% weekly VAR... probability level is part of a process known as backtesting Question ID: 7445 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