SECTION 3.3.1. LO.I. SECTION 3.3.1. LO.I.

5. Regarding the alternative methods of estimating VaR, who is correct?

A. Martin only.

B. Julia only.

C. Neither Martin nor Julia.

The following information relates to question 6 - 10

Vilma Atkinson is the head of risk at Preston Investments. She is having a discussion with her

assistant, Kyle Lee about the use of risk management tools in portfolio management. She asks

Kyle about the advantages and disadvantages of using scenario risk measures in risk

management along with VaR. Kyle states, "Scenario analysis can complement VaR as it

accounts for market liquidity, however, it carries a limitation that it has greater reliance on

historical market data than VaR."

Kyle further states, "An example of scenario analysis is reverse stress test, where the most

significant exposures of a portfolio are identified and generate a hypothetical stress that

adversely affects these exposures".

Vilma then discusses option risk measures and how they can be used to assess the risk exposures

of options positions. Kyle states, "Delta measures the sensitivity of option value to the price of

the underlying and it ranges from 0 to +0.5. Gamma is a second-order effect that measures the

sensitivity of delta to price changes in the underlying. Vega is a first-order effect for options

reflecting the relationship between the option price and the volatility of the underlying."

Later, Vilma asks Kyle to draft a risk management policy for the company's balance fund, which

is designed primarily for investors with a low risk tolerance and a goal to limit the likelihood of

severe downside losses. Kyle drafts the following risk management policy:

"The balanced fund has a 10-day, 2% VaR limit of $5 million and the fund will undertake

hedging activities if its cumulative 15 day loss ever exceeds $10 million."

Vilma then asks Kyle, "We have a diverse investor base including banks, corporations and long-

only asset managers. Which of these investors will prefer risk measures such as VaR expressed

as a percentage of assets and relative to a benchmark?"