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FRM Part II · FRM Exam Part II · Range of Practices and Issues in Economic Capital Frameworks

A bank measures market risk economic capital using a 99% ten-day VaR of USD 40 million for its trading book. To align with its one-year, 99.9% economic capital standard, an analyst first scales the horizon using the square-root-of-time rule, assuming 250 trading days per year and 10 days in the holding period. What is the one-year, 99% VaR?

The one-year 99% VaR is USD 200 million. The horizon ratio is 250 days divided by 10 days, which is 25, and the square-root-of-time rule scales risk by its square root, 5. Multiplying USD 40 million by 5 gives USD 200 million.

  1. AUSD 200 millionCorrect
  2. BUSD 8 million
  3. CUSD 1,000 million
  4. DUSD 400 million

Explanation

Scale by sqrt(250/10) = sqrt(25) = 5, so 40 x 5 = USD 200 million. Using 25 rather than its square root gives USD 1,000 million. Dividing by 5 gives USD 8 million. Multiplying by 10 gives USD 400 million. The confidence level is still 99% at this step.

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