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FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A pension fund's total assets are 500 million with a policy benchmark. The fund's absolute VaR at 95% over one month is 20 million. The fund's tracking error VaR (relative VaR) at the same confidence and horizon is 6 million. Which statement best describes what the 6 million figure measures?

The 6 million tracking error VaR measures the potential underperformance of the fund relative to its benchmark, in currency terms, at the stated confidence and horizon. It is based on active returns, not on the total loss of fund value, which is what absolute VaR captures.

  1. AThe maximum loss on total fund value that is expected to be exceeded only 5% of the time
  2. BThe potential shortfall of fund returns relative to the benchmark return, in currency terms, at the stated confidence levelCorrect
  3. CThe loss on the benchmark portfolio alone at the stated confidence level
  4. DThe diversification benefit between the fund and its benchmark

Explanation

Relative (tracking error) VaR is computed on the active return, the difference between portfolio and benchmark returns. It therefore measures underperformance versus the benchmark, not the loss in total value. The 20 million figure is the absolute VaR, which is the first option.

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