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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A bank's trading book has a market value of 400 million and a daily 99% VaR of 8 million under normal conditions. After a geopolitical shock, volatility of the book's returns rises by 50% with the same distribution shape and zero mean. Using a scaling approach, what is the new daily 99% VaR, and what does this imply for transmission to the bank?

The new daily 99% VaR is 12 million. With zero mean and unchanged distribution shape, VaR scales linearly with volatility, so a 50% rise multiplies 8 million by 1.5. This implies higher market-risk capital requirements and possible limit breaches as volatility transmits geopolitical stress to the trading book.

  1. A8 million, because VaR is independent of volatility
  2. B12 million, indicating higher market-risk capital needs and potential limit breachesCorrect
  3. C4 million, because higher volatility lowers VaR
  4. D16 million, because VaR scales with the square of volatility

Explanation

With zero mean and the same distribution shape, VaR is proportional to volatility. New VaR = 8 x 1.5 = 12 million. Check: 12/400 = 3% versus 2% before, which is 1.5 times. The squared-scaling option wrongly applies variance rather than standard deviation (it would give 18, not 16, so it is doubly wrong).

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