GARP Practice question - Market Risk Calc

Discussion in 'P2.T5. Market Risk (25%)' started by laksh25s@gmail.com, May 15, 2011.

  1. laksh25s@gmail.com

    laksh25s@gmail.com New Member

    Hi David,

    I refer to the below question in GARP Level 2 practice exam and the multiplication factor used. In the readings, it says that the Multiplication factor is subject to a floor of 3. Is this a floor or a cap - minimum or maximum. In the sense if the question mentions the multiplication factor as 2 are we supposed to change it to 3 - if thats what is meant by a floor.

    Once again thanks for your help.

    Question:
    11. As a risk manager for Bank ABC, John is asked to calculate the market risk capital charge of the bank’s trading portfolio under the internal models approach using the information given in the table below. Assuming the return of the bank’s trading portfolio is normally distributed, what is the market risk capital charge of the trading portfolio?
    • VaR (95%, 1-day) of last trading day USD 40,000
    • Average VaR (95%, 1-day) for last 60 trading days USD 25,000
    • Multiplication Factor 2
    a. USD 84,582
    b. USD 134,594
    c. USD 189,737
    d. USD 222,893

    Answer: d.
    Explanation:
    Market Risk Capital Charge = MAX(40,000 x SQRT(10)/1.65 x 2.326, 2 x 25,000 x SQRT(10)/1.65 x 2.326) = 222893
    Candidate is required to convert the VaR (95%, 1-day) to a 95% 10-day VaR.
    Topic: Operational and Integrated Risk Management
    Subtopic: Regulation and the Basel II Accord
    AIMS: Describe and contrast the major elements—including a description of the risks covered—of the two options
    available for the calculation of market risk: Standardized Measurement Method and Internal Models Approach
    Reference: “Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised
    Framework—Comprehensive Version” (Basel Committee on Banking Supervision Publication, June 2006).
  2. Hi Laksh,

    Right, good observation. I used this question in one of the live webinars and noted this same discrepancy. The answers don't allow for the "correct" 3x multiplier (334,340). I said i think it's a mistake and the multiplier should be 3.

    Re: cap or floor. It is a FLOOR.

    So, in my opinion, the question is flawed and it's on my errata list for GARP. The floor is k=3; so I can't make sense of k=2

    Thanks, David
  3. Laksh:

    FYI, here is the source Basel II with regard to the multiplier (emphasis mine):

    Part 2, VI. Market Risk, 4. Quantitative Standards:

    David
  4. jcjc0602

    jcjc0602 Member

    "Candidate is required to convert the VaR (95%, 1-day) to a 95% 10-day VaR."
    This sentence should be convert 95% VaR to 99% VaR. Otherwise, 1.65 and 2.326 in the formula is wrong.
    • Agree Agree x 1
  5. ShaktiRathore

    ShaktiRathore Well-Known Member

  6. jcjc0602

    jcjc0602 Member

  7. sleepybird

    sleepybird Active Member

    This is immaterial but bothers me
    They should be consistent with the decimal and use either 1.645 and 2.326 or 1.65 and 2.33
    • Like Like x 1
  8. sleepybird - I agree, and oh i long for the day when this can be the only inconsistency :rolleyes:

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