Understanding 95% VaR Implications

Very Hard Risk Management Measuring Risk

As a portfolio manager, you are conducting a comprehensive risk assessment for a client’s investment portfolio, which consists of multiple asset classes including equities, fixed income, and alternatives. The portfolio has a historical return of 10% with a standard deviation of 15%. Recently, you have captured data to compute the Value at Risk (VaR) for the portfolio at a 95% confidence level. The normal distribution assumption for the returns holds accurately.

Upon calculating, you determine the VaR to be $200,000. However, your client also lacks sufficient understanding of how this figure translates into potential monetary losses during stressful market conditions. To clarify further, you explain different measures of risk to illustrate the portfolio’s risk exposure.

Which of the following statements correctly evaluates the 95% VaR and its implications for the client's portfolio?

The 95% VaR indicates that there is a 5% probability the portfolio will exceed a $200,000 loss over the specified time horizon.

The 95% VaR implies that in 95 out of 100 simulated scenarios, the portfolio will not lose more than $200,000.

The 95% VaR means that, based on historical data, the portfolio will have an expected loss of $200,000 on average.

Hint

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