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

25. C is correct. Economic capital measures the shareholders’ equity required to overcome losses

under stress market conditions. A and B are true statements. Section 5.5. LO.l.

Set 2 Questions

The following information relates to questions 1 - 5.

Martin Cross, senior risk manager and Julia Bing, analyst at Gloria AMC are discussing the

VAR measure of risk management. Martin states, “It’s important to understand the three points

in the VaR concept. (1) VaR can be measured in either currency units or in percentage terms, (2)

it tells us how much one can lose, and (3) it references a time horizon, losses that would be

expected to occur a certain time.” Martin the asks Julia, “What does a VaR of $15 million at 5%

for one month indicate?”

Martin and Julia then talk about the advantages of VaR as a risk management tool. Julia

comments, "The advantages of VaR are: (1) it can be used for performance evaluation, (2) it

provides an estimate of losses during a worst-case scenario, and (3) it is an objective method

rather than a subjective method.”

Martin next calculates the VaR of one of the company's equity funds; the Gloria Delta fund. He

estimates the dollar VaR at the 5% level using the parametric method with the following inputs:

Exhibit 1: Data for Gloria Delta fund

Portfolio Value $600 million

Daily Expected Return 0.05%

Daily Expected Volatility 1.20%

Martin and Julia then discuss other methods of estimating VaR. Martin states, "Historical

simulation to estimate VaR is useful however it has a limitation that mean and variance estimates

could be biased". Julia says, "Monte Carlo method of estimating VaR has the advantage that the

number of necessary simulations is determined by the parameters".