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Reading 27 Risk Management FinQuiz.com FinQuiz.com CFA Level III Item-set - Question Study Session 14 June 2017 Copyright © 2010-2017 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2017 - All rights reserved Reading 27 Risk Management FinQuiz.com 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 FinQuiz.com © 2017 - All rights reserved Reading 27 Risk Management FinQuiz.com FinQuiz Question ID: 7442 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 not lead to a false sense of security FinQuiz Question ID: 7443 Flare is least accurate with respect to: A statement only B statement only C both statements and FinQuiz Question ID: 7444 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 FinQuiz Question ID: 7445 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 FinQuiz Question ID: 7446 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 FinQuiz Question ID: 7447 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 FinQuiz.com © 2017 - All rights reserved .. .Reading 27 Risk Management FinQuiz. com FinQuiz Item- set ID: 7441 Questions 1(7442) through 6(7447) relate to Reading 27 Rupert Mindanao Case Scenario Rupert... decides that the model is not accurate and needs adjustments FinQuiz. com © 2017 - All rights reserved Reading 27 Risk Management FinQuiz. com FinQuiz Question ID: 7442 With regards to the drawbacks... lead to a false sense of security FinQuiz Question ID: 74 43 Flare is least accurate with respect to: A statement only B statement only C both statements and FinQuiz Question ID: 7444 The process
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