FRM I 2016 - Var Quiz 2

5/28/2016 FRM I 2016: Var Quiz 2
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Var Quiz 2
Review of attempt 1
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Started on Saturday, 28 May 2016, 11:27 AM
Completed on Saturday, 28 May 2016, 11:28 AM
Time taken 10 secs
Raw score 0/25 (0%)
Grade 0 out of a maximum of 10
1
Marks: 1 Based on a 90% confidence level, how many exceptions in back testing a VaR would be expected over a 250day
trading year?
Choose one answer.
Choose one a. 50
answer.
b. 10
c. 25
d. 15
The correct answer is 25.
The number of exceptions = (1 – confidence interval) * (number of days) = (1 –0.90) * (250) = 25
Incorrect
Marks for this submission: 0/1.
2
Marks: 1 You have a portfolio with a large investment in the Carpathia EUR 6% 07 bond. This bond rarely trades.
Indicative bid prices for small size trades are posted for the bond, but they are mostly from dealers wanting to
express a willingness to make negotiated trades. However, the Carpathia USD 9 3/8% 11 bond is liquid. Its dollar
return is uncorrelated with the EUR/USD rate. Which of the following statements is correct?
Choose one answer.
Choose one a. The oneday VaR for the Carpathia EUR 6% 07 bond using daily indicative bid prices
answer. for the bond is an upwardbiased estimate of the risk of the bond because the bidask
spread on an illiquid bond is large
b. It is more appropriate to estimate the VaR of the Carpathia EUR bond using a mix of
bonds to account for errors in the bond prices than just using the EUR bond
c. Unless a EUR futures position and a long position in the Carpathia USD bond replicate
the Carpathia EUR bond, the VaR for the EUR bond should be computed over a multiple
day horizon to account for illiquidity
d. The oneday USD VaR computed using the dollar return of the Carpathia USD 9 3/8%
11 bond is an unbiased estimate of the risk of the Carpathia EUR 6% 07 in dollars
The correct answer is Unless a EUR futures position and a long position in the Carpathia USD bond replicate the
Carpathia EUR bond, the VaR for the EUR bond should be computed over a multiple day horizon to account for
illiquidity.
The traditional VAR models are, by construction, static. Increasing the risk horizon from one day to multiple days
does not make the model static. Additionally, traditional VAR models assume to use market data from liquid
markets. Liquidity risk cannot be factored into a traditional VAR model. Thus, unless the EUR bond can be
replicated by a liquid EUR futures position and a long position in the 9 3/8% 11 bond (both of which are liquid
assets), dynamic VAR must be used.
Incorrect
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5/28/2016 FRM I 2016: Var Quiz 2
3
Marks: 1 Given the following 30 ordered simulated percentage returns of an asset, calculate the VAR and expected shortfall
(both expressed in terms of returns) at a 90% confidence level.16, 14, 10, 7, 7, 5, 4, 4, 4, 3, 1, 1, 0,
0, 0, 1, 2, 2, 4, 6, 7, 8, 9,11, 12, 12, 14, 18, 21, 23
Choose one answer.
Choose one a. VAR (90%) = 10, Expected shortfall = 14
answer.
b. VaR (90%) = 14, Expected shortfall = 15
c. VaR (90%) = 18, Expected shortfall = 22
d. VAR (90%) = 10, Expected shortfall = 15
The correct answer is VAR (90%) = 10, Expected shortfall = 15.
Ten percent of the observations will fall at or below the 3rd lowest observation of the 30 listed. Therefore, the VaR
equals 10. The expected shortfall is the mean of the observations exceeding the VaR. Thus, the expected shortfall
equals (16 + 14) / 2 = 15
Incorrect
4
Marks: 1 Which one of the following statements about the delta normal VAR methodology is NOT true?
Choose one answer.
Choose one a. It cannot account for nonlinear effects such as those resulting from embedded
answer. options.
b. It may underestimate the occurrence of large observations due to its reliance on a
normal distribution
c. It is appropriate for allocating economic capital for a fixed income desk unless it
contains many bonds with embedded options.
d. It is similar to historical simulation except that the movements in risk factors are
generated by drawing from some distribution.
The correct answer is It is similar to historical simulation except that the movements in risk factors are generated
by drawing from some distribution.
Incorrect
5
Marks: 1 If you use deltaVAR for a portfolio of options, which of the following statements is always correct?
Choose one answer.
I. It necessarily understates the VaR because it uses a linear approximation.
II. It can sometimes overstate the VaR.
III. It performs most poorly for a portfolio of deepinthe money options.
IV.It performs most poorly for a portfolio of deepoutofthe money options.
Choose one a. I only
answer.
b. II only
c. III & IV only
d. All of the above
The correct answer is B
This question has to be read very carefully in view of the “always” characterization. The deltaVAR could
understate or overstate the true VAR, depending on whether the position is net long or short options, so St1) is
incorrect. The deltaVAR is generally better for inthemoney options, because these have low gamma, so St2) is
false for outofthemoney options, delta is close to zero, so the deltaVAR method would predict zero risk. The
risk could indeed be very small, so St4) is incorrect. So, St2) is the most general statement.
Incorrect
6
Marks: 1 Which of the following procedures is essential in validating the VAR estimates?
Choose one answer.
Choose one a. Scenario analysis
answer.
b. Back testing
5/28/2016 FRM I 2016: Var Quiz 2
c. Once approved by regulators, no further validation is required.
d. Stress testing
The correct answer is back testing, VAR estimates need to be compared to actual P&L results to be validated,
which is called back testing.
Incorrect
7
Marks: 1 A relative value hedge fund manager holds a long position in Asset A and a short position in Asset B of roughly
equal principal amounts. Asset A currently has a correlation with Asset B of 0.97; the risk manager decides to
overwrite this correlation assumption in the variancecovariance based VAR model to a level of 0.30. What effect
will this change in correlation from 0.97 to 0.30 have on the resulting VAR measure?
Choose one answer.
Choose one a. Do not have enough information to answer.
answer.
b. It has no effect on var, but changes profit or loss of strategy.
c. It increases var
d. It decreases var
The correct answer is it increases VAR.
It increases var with the correlation of 0.97, any increase ( decrease) in value in the short position in asset B will
be almost completely offset by a decrease ( increase) in the long position in asset A, which implies a very low
VAR. Reducing the correlation to 0.30 reduces the effectiveness of this hedge, which implies a higher VAR.
Incorrect
8
Marks: 1 Which of the following is NOT a required step in using the delta normal method to determine VAR for a fixed
income portfolio?
Choose one a. Apply convexity adjustments to the mapped positions
answer.
b. Compute the mean, the standard deviation, and the VAR
c. Decompose and map the portfolio.
d. Determine the changes in the values of the market factors.
The correct answer is A: Apply convexity adjustments to the mapped positions.
Incorrect
9
Marks: 1 The expected loss given that the loss has exceeded the VAR is best described as the:
Choose one a. Economic capital.
answer.
b. Poisson parameter.
c. Unexpected loss.
d. Expected shortfall.
The correct answer is D: Expected shortfall.
Incorrect
10
Marks: 1 The measurement error in VAR, due to sampling variation, should be greater with
Choose one a. More observations and a high confidence level (e.g., 99%)
answer.
b. Fewer observations and a high confidence level
c. More observations and a low confidence level (e.g., 95%)
d. Fewer observations and a low confidence level
5/28/2016 FRM I 2016: Var Quiz 2
The correct answer is D: fewer observations and a high confidence level. Sampling variability (or imprecision)
increases with (1) fewer observations and (2) greater confidence levels. To show (1), we can refer to the formula
for the precision of the sample mean, which varies inversely with the square root of the number of data points. A
similar reasoning applies to (2). A greater confidence level involves fewer observations in the left tails, from which
VAR is computed.
Incorrect
11
Marks: 1 In early 2000, a risk manager calculates the VAR for a technology stock fund based on the last three years of
data. The strategy of the fund is to buy stocks and write out of the money puts. The manager needs to compute
VAR. Which of the following methods would yield results that are least representative of the risks inherent in the
portfolio?
Choose one a. St1: Historical simulation with full repricing
answer.
b. St2: Delta normal VaR assuming zero drift
c. St3: Monte Carlo style VaR assuming zero drift with full repricing
d. St4: Historical simulation using deltaequivalents for all positions
The correct answer is Historical simulation using deltaequivalents for all positions.
Because the portfolio has options, methods St1) or St3) based on full repricing would be appropriate. Next, recall
that technology stocks have had a big increase in price until March 2000. From 1996 to 1999, the Nasdaq index
went from 1300 to 4000. This creates a positive drift in the series of returns. So, historical simulation without an
adjustment for this drift would bias the simulated returns upward, thereby underestimating VAR.
Incorrect
12
Marks: 1 Deltanormal, historical simulation, and Monte Carlo are various methods available to compute VAR. If underlying
returns are normally distributed, then
Choose one a. Deltanormal method VAR will be identical to the historicalsimulationVAR.
answer.
b. Deltanormal method VAR will be identical to the Monte Carlo VAR.
c. Monte Carlo VAR will approach the deltanormal VAR as the number of replications
(“draws”) increases.
d. Monte Carlo VAR will be identical to the historicalsimulation VAR.
The correct answer is C: Monte Carlo VAR will approach the deltanormal VAR as the number of replications
(“draws”) increases.
Infinite samples, the simulation methods will be in general different from the deltanormal method, and from
each other. As the sample size increases, however, the MonteCarlo VAR should converge to the deltanormal VAR
when returns are normally distributed.
Incorrect
13
Marks: 1 Value at risk (VAR) can be viewed as a measure of risk capital, which is the economic capital, required supporting
a financial activity. Economic capital is the amount of capital that should be set aside as a cushion against:
Choose one a. Unexpected losses.
answer.
b. Catastrophic losses.
c. Expected losses
d. Expected and unexpected losses
The correct answer is A: Unexpected losses.
Incorrect
14
Marks: 1 What is the correct interpretation of a $3 million overnight VAR figure with 99% confidence level? The institution
5/28/2016 FRM I 2016: Var Quiz 2
Choose one a. Can be expected to lose at most $3 million in 1 out of next 100 days
answer.
b. Can be expected to lose at least $3 million in 95 out of next 100 days
c. Can be expected to lose at least $3 million in 1 out of next 100 days
d. Can be expected to lose at most $6 million in 2 out of next 100 days
The correct answer is A: Can be expected to lose at least $3 million in 1 out of next 100 days. On average, a loss
worse than VAR should arise n = 1%× 100 = 1 day out of 100.
Incorrect
15
Marks: 1 Under what circumstances is it appropriate to scale up a VAR estimate from a shorter holding period to a longer
holding period using the square root of time?
Choose one a. It is never appropriate.
answer.
b. It is always appropriate.
c. When either mean reversion or trend are present in the historical data series.
d. When neither mean reversion nor trend are present in the historical data series.
The correct answer is D: when neither mean reversion nor trend are present in the historical data series. The
presence of either mean reversion or trend (or time variation in risk) implies a different distribution of returns for
different holding periods.
Incorrect
16
Marks: 1 In the presence of fat tails in the distribution of returns, VAR based on the deltanormal method would (for a
linear portfolio)
Choose one a. Underestimate the true VAR
answer.
b. Be the same as the true VAR
c. Overestimate the true VAR
d. Cannot be determined from the information provided
The correct answer is A: Underestimate the true VAR.
With fat tails, the normal VAR would underestimate the true VAR.
Incorrect
17
Marks: 1 Consider the following single bond position of $10 million, a modified duration of 3.6 years, an annualized yield
volatility of 2%. Using the duration method and assuming that the daily return on the bond position is
independently identically normally distributed, calculate the 10day holding period VAR of the position with a
99% confidence interval, assuming there are 252 business days in a year.
Choose one a. $409,339
answer.
b. $396,742
c. $345,297
d. $334,186
The correct answer is D: $334186.
The VAR is given by alpha*sigma(dP) sqrtT, where sigma(dP) = (PD*)sigma(dy).
The dollar duration is (PD*) = $36 million. The worst daily movement in yields is alpha*sigma(dy) sqrtT =2.33 ×
0.02 (10/252) = 0.009283. TheVARis then $36,000,000 × 0.009283 = $334,186.
Incorrect
18
Marks: 1 Which of the following is not true about GARCH model?
I.The model is generalized case of Risk metrics
5/28/2016 FRM I 2016: Var Quiz 2
II. In GARCH (1,1) model the period t conditional volatility of a function of period t1 conditional volatility and
the return from t1 to be squared.
III.The estimates of GARH model are more accurate than the RiskMetrics model
IV.It enable to model the volatility as time varying and predictable
Choose one a. II and IV
answer.
b. I
c. III
d. I, II, III
The correct answer is C: III only. The estimates of RiskMetrics model are more accurate than the GARCH model.
Incorrect
19
Marks: 1 What are the similarities between the Risk Metrics and STDDEV
I.Both methods are parametric
II.Both methods attempt to estimate conditional volatility
III.Both methods use Simulations
IV Both methods use historical and future projected data.
Choose one a. I, IV
answer.
b. I, II
c. I, III
d. III and IV
The correct answer is B: I, II. Other similarities are both methods use historical data and apply a set of weights
to past squared returns.
Incorrect
20
Marks: 1 Which of the following is true with respect to DeltaNormal VaR?
I. Parametric deltanormal VaR is higher than historical VaR
II.The deltanormal method provides accurate estimates of VaR by generating a covariance (correlation) matrix
and measuring VaR using relatively simple matrix multiplication.
III.If underlying returns are normally distributed (ND), then VAR will approach the deltanormal VAR as the
number of replications increases
IV.Historical simulation VAR will be in different from the deltanormal method, as the sample size increases, they
converge when the returns are Normally distributed.
Choose one a. II, III and IV
answer.
b. I, II
c. I, IV
d. I, II, III
The correct answer is A: II, III and IV. Parametric deltanormal VaR is lower than historical VaR.
Incorrect
21
Marks: 1 Which of the following is true about EWMA model?
I.The value of lamda in EWMa model is 1< lamda< 1
II.Higher lamda closer to unity, exhibits a slower decay in information relevance with less weight on recent
observations.
III.Exponential smoothening places exponentially declining weights on historical data.
Choose one a. II , III
answer.
b. III Only
c. I, II, III
d. I Only
The correct answer is A: II, III. The value of lamda in EWMa model is 0< lamda< 1.
5/28/2016 FRM I 2016: Var Quiz 2
Incorrect
22
Marks: 1 An American bank has a cash position of €1 million. The euro exchange rate is 0.95 USD/EUR. The 1day euro
exchange rate is normally distributed with mean 0.96 and standard deviation 0.01. Compute the 1day VaR with
99% confidence (in USD)
answer.
b. $16,500
c. $13,300
d. $19,600
The correct answer is C: $13,300. Lower EUR = 0.96 2.33 × 0.01 = 0.9367; 1m EUR = $936700
; VaR = $950,000 $936700 = $13,300.
Incorrect
23
Marks: 1 Consider the following information. You have purchased 10,000 barrels of oil for delivery in one year at a price of
$25/barrel. The rate of change of the price of oil is assumed to be normally distributed with zero mean and
annual volatility of 20%. You have a margining agreement in place with the counterparty that requires margin to
be paid within two days if the credit exposure becomes greater than $60,000. There are 252 business days in the
year. Assuming enforceability of the margin agreement, which of the following is the closest number to the 95%,
1year credit risk of this deal governed under the margining agreement?
answer.
b. $67,350
c. $82,500
d. $58,000
The correct answer is B: $67,350. This question is designed to test the understanding of how margin agreements
decrease credit risk. In this case, the correct answer is the margin agreement plus a 2day VaR: $60,000 +
$7,350 = 67350.
2 day VAR = (1.65 * 10000*25 * 0.2*Sqrt2)/ (Sqrt252) = 7350.
Incorrect
24
Marks: 1 Which of the following is incorrect about Stresstesting
I.Stresstesting is a key risk management process, which includes (1) scenario analysis, (2) stressing models,
volatilities, and correlations, and (3) developing policy responses
II.Stresstesting is a statistical risk measure
III.The drawback of Stress testing is that it’s highly subjective.
IV.VaR analysis should be complemented by stress testing because stress testing Identifies losses that go beyond
the normal losses measured by VaR
Choose one a. II only
answer.
b. I, III
c. I, IV
d. I , III
The correct answer is A: II only. Stresstesting is a nonstatistical risk measure.
Incorrect
25
Marks: 1 Which of the following are correct about Scenario analysis.
I.Unidimensional Scenarios provide an intuitive understanding of the effect of movements in the key variable ,
they also account for correlations
II.SPAN systems are used to identify movements in a portfolio under series of scenarios.
III.Prospective scenarios represent hypothetical one –off surprises that are analysed in terms of their effects on
5/28/2016 FRM I 2016: Var Quiz 2
financial markets.
IV.Historical scenarios can examine historical data to provide examples of joint movements in financial markets.
Choose one a. II,III and IV
answer.
b. I, II, III
c. I Only
d. III Only
The correct answer is A: II, III and IV. Unidimensional Scenarios provide an intuitive understanding of the effect
of movements in the key variable , they do not account for correlations
Incorrect
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EduPristine ► FRM I 2016 ► Quizzes ► Var Quiz 2 ► Review of attempt 1

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