Question

[10:10 AM, 3/31/2020] M: Tina Ming is a senior portfolio manager at Flusk Pension Fund (Flusk). Flusk’s portfoliois composed of fixed- income instruments structured to match Flusk’s liabilities. Mingworks with Shrikant McKee, Flusk’s risk analyst.Ming and McKee discuss the latest risk report. McKee calculated value at risk (VaR)for the entire portfolio using the historical method and assuming a lookback period offive years and 250 trading days per year. McKee presents VaR measures in Exhibit 1.

Exhibit 1: Flusk Portfolio VaR (in $ millions)

Confidence Interval Daily VaR Monthly VaR

95% 1.10 5.37

After reading McKee’s report, Ming asks why the number of daily VaR breachesover the last year is zero even though the portfolio has accumulated a substantial loss.Next Ming requests that McKee perform the following two risk analyses on Flusk’sportfolio:Analysis 1 Use scenario analysis to evaluate the impact on risk and return of arepeat of the last financial crisis.Analysis 2 Estimate over one year, with a 95% level of confidence, how muchFlusk’s assets could underperform its liabilities.Ming recommends purchasing newly issued emerging market corporate bondsthat have embedded options. Prior to buying the bonds, Ming wants McKee to estimatethe effect of the purchase on Flusk’s VaR. McKee suggests running a stress testusing a historical period specific to emerging markets that encompassed an extremechange in credit spreads.

At the conclusion of their conversation, Ming asks the following question aboutrisk management tools: “What are the advantages of VaR compared with other riskmeasures?”

Based on Exhibit 1, Flusk’s portfolio is expected to experience:

       
a minimum daily loss of $1.10 million over the next year.

       
a loss over one month equal to or exceeding $5.37 million 5% of the time.

       
an average daily loss of $1.10 million 5% of the time during the next 250trading days.

Answer 1

VaR Tables of the Portfolio :

Confidence Interval	Daily Var	Monthly Var
95%	1.10	5.37

Var Value confirms Chances of loss (1- Confidence Interval) More than Var value in Each time frame.

Here Daily Var 1.10 in 95% CI confirms 5% instances of loss more than $ 1.10 in each trading days.

Answer:

a)  a minimum daily loss of $1.10 million over the next year -(Wrong Answer) - Daily VaR confirms $ 1.1 Million or more will be loss in case of 1 - 95% = 5% case.

b)  a loss over one month equal to or exceeding $5.37 million 5% of the time.(True ) - Monthly VaR confirms $ 5.37 or higher loss in a month 5% of the time.

c) an average daily loss of $1.10 million 5% of the time during the next 250trading days. - (True) - Daily VaR confirms $ 1.1 Million or more will be loss in case of 1 - 95% = 5% case. for each trading day

.

A Probability confidence Intergat. LOSSES. Gains. Change in portfolio Value.