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".
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