Estimating market risk measures

Discussion in 'P2.T5. Market Risk (25%)' started by Imad, Jul 26, 2012.

  1. Imad

    Imad Member

    Hi David

    Hope you are well. Appreciate if you could explain below example taken from Qbank. I couldn't understand the relation btwn PVBP and VAR?


    Question 11 - #29487
    The price value of a basis point (PVBP) of a $20 million bond portfolio is $25,000. Interest rate changes over the next one year are summarized below:
    Change in Interest rates
    Compute VAR for the bond portfolio at 95 percent confidence level.
    The correct answer was C) $5,000,000.
    At 5% probability level change in interest rates is 2.00% or higher.Change in Portfolio value for 200 bps change in interest rate = 200*$25,000VAR = $5,000,000.
  2. David Harper CFA FRM CIPM

    David Harper CFA FRM CIPM David Harper CFA FRM (test)

    Hi Imad,

    The question assumes that an adverse change to the value of the (long) bond portfolio is a increase in the interest rate (higher rate --> lower bond price), such that the worst expected 95/5% outcome is the +2% increase in the rate (e.g., the 99% worst would be the +2.5% increase). I find it easier to be flexible w.r.t 5% or 95% and just focus on: we want the adverse tail (causing a drop in value) and we can perceive the adverse tail as either 95% or 5%, which is here an (presumed!) increase in the rate (although notice a better question would specify the portfolio is long; if it were short, the worst expected 5%/95% would be a 1% rate drop.)

    I don't know why the probabilities don't appear to sum to 1.0 (part of the definition of a prob distribution is summation to 1.0)

    finally, PVBP (which is more commonly referred to as DV01 in the FRM, but they are the same) is the dollar increase associated with a one basis point decline (so it's approx equal to dollar decrease associated with a one basis point increase). There are 200 basis point in +2%. So answer is +2% * 100 bps/% * $25,000 change/bps. Thanks,
  3. Aleksander Hansen

    Aleksander Hansen Well-Known Member

    Just another example of why Bionic Turtle is superior in terms of practice questions:
    1) Correct answer
    2) More insightful and well thought through questions
    3) Rapid response, with an intuitive, easy-to-understand answer.
    • Like Like x 1

Share This Page