VaR question- TT #11 (Babb Partners Case Scenario)

CFA Level III
#1

In this question, why could we not use Mean Return (1.53%) & Fund Return Volatility (6.47%)? This is what Analytical method of calculating VaR does…

Further, when do we use the probability distribution (as used in solution) vs. “E® – volatility method”?

EXHIBIT 1

MKY FUND A: PROBABILITY DISTRIBUTION OF RETURNS BASED ON THE PAST 10 YEARS OF PERFORMANCE

Fund Return

−25%

−20%

−12%

−8%

−2%

0%

6%

9%

Probability

0.005

0.02

0.025

0.15

0.2

0.25

0.25

0.1

Mean Fund Return: 1.53% annually

Fund Return Volatility: 6.47% annually

#2

It’s a trick question. The chart they give you is for historical losses. You would add the p values up to 5% (or whatever the VaR level states I can’t remember the question) to get the historical loss. If it’s 5% it would represent a -12% historical loss and your 5% var would be value*-12%.

The trick is that they’re not asking you to use analytical method, they’re asking you to use historical method.

#3

Thanks- but thats not how the historical method has been calculated in curriculum (VaR reading BB #6 (page 161))

for 10 years, annual VaR (using historical method) would be 10yr * 5% = 0.5 (i.e. go with the worst possible calculation)…which is not how they did this.

I get the solution- reminds of Level 1 Stats!

#4

Yeah it’s a different way than having the list of top 100 and 5% would be the 5th worst performing period returns. I agree this was tricky I missed it but realized that it was really a historical var question and not an analytical var.