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CA Final · Advanced Financial Management · Risk Management

Two equity positions held by a Pune investment firm are Rs 6 crore in stock A and Rs 8 crore in stock B. Their individual 1-day 95% VaRs are Rs 0.30 crore and Rs 0.40 crore respectively, and the correlation of their returns is zero. What is the diversified portfolio 1-day 95% VaR under the parametric method?

The diversified VaR is Rs 0.50 crore. With zero correlation the individual VaRs combine as the square root of the sum of their squares, sqrt(0.09 + 0.16) = 0.50, which is lower than the simple sum of Rs 0.70 crore because of diversification.

  1. ARs 0.70 crore
  2. BRs 0.10 crore
  3. CRs 0.25 crore
  4. DRs 0.50 croreCorrect

Explanation

With zero correlation, portfolio VaR = sqrt(0.30^2 + 0.40^2) = sqrt(0.09 + 0.16) = sqrt(0.25) = Rs 0.50 crore. Rs 0.70 crore simply adds the VaRs, which assumes perfect correlation of +1 and ignores diversification.

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