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FRM Part II · FRM Exam Part II · VaR Mapping

A risk manager at an asset management firm holds thousands of bonds with different maturities and coupons. Rather than modelling each bond's price history individually, she represents each position as exposures to a small set of standardized risk factors. What is the primary purpose of this VaR mapping?

The main purpose of VaR mapping is to reduce dimensionality by expressing many positions as exposures to a limited set of common risk factors. This makes risk estimation tractable and handles instruments lacking price history. It is a measurement simplification, not a hedge and not a guarantee of accuracy.

  1. ATo replace the portfolio's actual cash flows with a lower expected return
  2. BTo reduce the dimensionality of the problem by expressing positions in terms of a limited number of common risk factorsCorrect
  3. CTo eliminate market risk by matching positions to hedging instruments
  4. DTo guarantee that the VaR estimate equals the realized loss at the chosen confidence level

Explanation

VaR mapping replaces many individual positions with exposures to a manageable set of primitive risk factors. This makes covariance estimation feasible and handles instruments with short or no price history. It does not hedge risk or change expected returns.

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