FRM Part II · FRM Exam Part II · Liquidity and Leverage
A desk holds USD 50 million of a bond. Its 1-day 99% VaR is USD 1.0 million. The mean proportional bid-ask spread is 0.40% and the spread standard deviation is 0.10%, with a 99% multiplier of 2.33. Using the exogenous-spread approach, what is LVaR?
LVaR equals VaR plus half of the mean spread plus 2.33 spread standard deviations, times position value. Here the cost is 0.5 x 0.633% x 50 million, about 0.158 million, so LVaR is about USD 1.16 million.
- AUSD 1.10 million
- BUSD 1.16 millionCorrect
- CUSD 1.20 million
- DUSD 1.32 million
Explanation
Spread term = 0.40% + 2.33 x 0.10% = 0.633%. Half is 0.3165%. Times 50m = 0.15825m. LVaR = 1.0 + 0.158 = about USD 1.16m. Using the full spread rather than half would give 1.32m, which is the key mistake.
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