Understanding Value at Risk In Portfolio Management

Hard Risk Management Applications Value At Risk

A portfolio manager is analyzing the risk of a multi-asset portfolio that consists of equities, fixed income securities, and alternative investments. To quantify the potential loss in the value of the portfolio under normal market conditions, the manager decides to utilize Value at Risk (VaR) as the risk measurement tool.

The portfolio currently has a market value of $10 million, and the portfolio manager computes a 1-day VaR at the 95% confidence level to be $500,000. This implies that there is a 5% chance that the portfolio could lose more than $500,000 in one day.

Given this context, which of the following statements about the portfolio’s Value at Risk is correct?

The VaR measurement indicates that the portfolio is expected to lose less than $500,000 on 95% of the trading days.

The VaR value can be interpreted as the average loss the portfolio might incur during the worst 5% of days.

The VaR calculation assumes that losses are normally distributed and does not account for extreme market movements.

Hint

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