FRM Part II · FRM Exam Part II · VaR Mapping
A risk manager is building a VaR system for a large bond portfolio containing thousands of different bonds. Which approach best describes the principle of mapping the portfolio to risk factors?
Fixed-income mapping replaces each bond's cash flows with positions in a small set of standardized zero-coupon vertices. This reduces the number of risk factors needing volatility and correlation estimates, making VaR computation feasible for large portfolios while still capturing term-structure risk.
- AReplace each bond's cash flows with positions in a small set of standardized vertices of the zero-coupon curveCorrect
- BModel each bond individually with its own volatility estimate from its price history
- CExclude all bonds with maturities that do not match a benchmark vertex
- DConvert every bond into a single position in the overnight rate
Explanation
Mapping decomposes each bond into cash flows and allocates them to standard vertices, so only a limited number of risk factors need volatility and correlation estimates. Modeling each bond separately is infeasible with thousands of bonds, and excluding bonds or using a single overnight rate discards risk information.
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