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

A risk committee sets a mandate for an index-tracking fund. Which risk limit is most appropriate for monitoring whether the manager is staying close to the mandate?

A tracking error VaR limit relative to the benchmark is most appropriate because an index-tracking mandate is judged by deviation from the benchmark, not by total loss. Absolute VaR mainly reflects market-wide moves that the manager is supposed to replicate.

  1. AA limit on absolute VaR of total fund value
  2. BA limit on tracking error VaR relative to the benchmarkCorrect
  3. CA limit on the risk-free rate exposure
  4. DA limit on the fund's total assets under management

Explanation

An index-tracking mandate is judged on deviation from the benchmark, so risk is best controlled with a relative VaR or tracking error limit. Absolute VaR would mostly reflect market moves common to the index and so would not show active deviation.

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