Value at Risk

Questions, Exercises and Previous Years Exams

A) Multiple Choice

1. Which of the following is true

a) Expected shortfall is always less than VaR
b) Expected shortfall is always greater than VaR
c) Expected shortfall is sometimes greater than VaR and sometimes less than VaR
d) Expected shortfall is a measure of liquidity risk whereas VaR is a measure of market risk

2. A German bank has exposure to the S&P500. Which of the following is true
a) The S&P 500 index should be always be measured in U.S. dollars when VaR is calculated
b) The S&P 500 index should be always be measured in euros when VaR is calculated
c) Either A or B can be done
d) The S&P 500 index should be measured in euros only if the bank has not got a U.S. subsidiary.

3. In the case of interest rate movements the most important factor risk corresponds to
a) A parallel shift
b) A slope change
c) A bowing
d) An increase in short rates

4. Which of the following is true of the historical simulation method for calculating VaR?
a) it fits historical data on the behavior of variables to a normal distribution
b) It fits historical data on the behavior of variables to a lognormal distribution
c) It assumes that what will happen in the future is a random sample from what has happened
in the past
d) It uses Monte Carlo simulation to create random future scenarios
5. Which of the following is true when delta, but not gamma, is used in calculating VaR for option
positions?
a) VaR for a long call is too low and VaR for a long put is too low
b) VaR for a long call is too low and VaR for a long put is too high
c) VaR for a long call is too high and VaR for a long put is too low
d) VaR for a long call is too high and VaR for a long put is too high

6. An analyst at C&R International Bank has been asked to explain the calculation of VaR for
linear derivatives to the newly hired junior analysts. Which of the following statements best
describes the calculation of the VaR for a linear derivative on the S&P500 Index?
a) For a futures contract, multiply the VaR of the S&P500 Index by a sensitivity factor reflecting
the percent change in the value of the futures contract for a 1% change in the index value.
b) For an options contract, multiply the VaR of the S&P500 Index by a sensitivity factor reflecting
the percent change in the value of the options contract for a 1% change in the index value.
c) For a futures contract, divide the VaR of the S&P500 Index by a sensitivity factor reflecting the
percent change in the value of the futures contract for a 1% change in the index value.
d) For an options contract, divide the VaR of the S&P500 Index by a sensitivity factor reflecting
the percent change in the value of the options contract for a 1% change in the index value.

7. A Portfolio manager of an endowment wants to calculate a daily VaR for the portfolio. The
€5.000.000 portfolio is restricted form using derivative securities. The manager uses a 5% level
of significance to estimate the VaR. The manager ranked the 100 daily returns form last year,
and reports the lowest eight returns to be: -0.0159, -0.0132, -0.0211, -0.0106, -0.0254, -0.0099,
-0.0369, and -0.0584. Which of the following amounts is closest to the daily VaR using the
historical simulation method?
a) -€66.000.
b) -€79.500.
c) -€105.500.
d) -€127.000.

8. When is a Monte Carlo Approach most advantageous for computing VaR:

a) in volatile markets.
b) when the markets expected behavior is non-normally distributed.
c) when quick calculations are requested.
d) when regulators are getting nervous about VaR calculations.
9. The properties of a coherent risk measure are all of the following except:
a) If one portfolio always produces a worse outcome than another its risk measure should be
greater.
b) If we add an amount of cash K to a portfolio its risk measure should go down by K.
c) Changing the size of a portfolio by  should result in the risk measure being multiplied by
.
d) The risk measures for two portfolios after they have been merged should be greater then
the sum of their risk measures before they were merged.

10. Which of the following is true about stress testing?

a) It is used to evaluate the potential impact on portfolio values of unlikely, although plausible,
events or movements in a set of financial variables.

b) It is a risk management tool that directly compares predicted results to observed actual
results.

c) Both a) and b) above are true.

d) None of the above are true.

11. For which of the following purposes is a high confidence level advisable?
a) for backtesting purposes
b) as a benchmark measure of downside risk for trading desks
c) for capital adequacy purposes
d) none of the above

12. The gain from a project is equally likely to have any value between -$0.15 million and +$0.85
million. What is the 99% value at risk?
a) $0.145 million
b) $0.14 million
c) $0.13 million
d) $0.10 million
 B) Open Questions

Question 1:
Suppose you have an inventory of 1000 barrels of crude oil which is priced in US dollars but you
are an UK company. The price volatility of your inventory is therefore expressed in sterling (since
your operating costs etc are also in sterling).

The current spot price of Oil is Soil = 70$/barrel and the current sterling-USD exchange rate is
$1,70 per pound (SFX = 0,5882GBP per $) and the daily volatility of oil prices is 2.0% per day and
the daily volatility of the exchange rate is 0.5% per day. Oil prices and the USD exchange rate
are slightly negatively correlated, so when oil prices rise, then 1-USD buys less GBP, so that their
correlation is -0.1.

a) Intuitively, what determines the VaR?

b) How would you calculate the VaR 95% in sterling (GBP) over 25-days (using the variance
covariance method)?

c) What is the diversification effect on this VaR?

Question 2:
Some time ago a company has entered into a forward contract to buy £1 million for $1.5 million.
The contract now has six months to maturity. The daily volatility of a six-month zero-coupon
sterling bond (when its price is translated to dollars) is 0.06% and the daily volatility of a six-
month zero-coupon dollar bond is 0.05%. The correlation between returns from the two bonds
is 0.8. The current exchange rate is 1.53. Calculate the standard deviation of the change in the
dollar value of the forward contract in one day.

a) What is the 10-day 99% VaR?

Assume that the six-month interest rate in both sterling and dollars is 5% per annum with continuous
compounding.

b) Describe three ways of handling interest-rate-dependent instruments when the model

building approach is used to calculate VaR. How would you handle interest-rate-dependent
instruments when historical simulation is used to calculate VaR?

Question 3:
A company has a position in bonds worth $6 million. The modified duration of the portfolio is
5.2 years. Assume that only parallel shifts in the yield curve can take place and that the standard
deviation of the daily yield change (when yield is measured in percent) is 0.09.
a) Use the duration model to estimate the 20-day 90% VaR for the portfolio.

b) Explain carefully the weaknesses of this approach to calculating VaR.

Explain two alternatives that give more accuracy.

Question 4:
Consider a $1 Million Treasury Bond maturing in 0,8 years, with 10% semi-annual coupon.
Suppose that the rates and zero-coupon prices are as follows:
3 Months 6 Months 12 Months
Zero Yield 5,50% 6,00% 7,00%
Zero Price Volatility 0,06% 0,10% 0,20%
(% per day)

Assume the following daily returns correlations:

3 Months 6 Months 12 Months
3 Months 1,00 0,90 0,60
6 Months 0,90 1,00 0,70
12 Months 0,60 0,70 1,00

What is the 10-day VaR of this position in the Treasury Market?

Question 5:
Consider a portfolio of $100 invested in two currencies:
 CAD position: $50
 EUR position: $50
The volatility of the CAD is 30% and the volatility of the EUR is 40%. The correlation between the
2 currencies is zero.

a) Compute the 95% individual VaR of each currency.

b) What is the VaR of the diversified portolio?
c) Compute the incremental VaR for each currency.
d) Compute the component VaR for each currency.