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Tutorial 8 (10)

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salmarefaie
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International Financial

Management
24BFIN06H

Tutorial 8: Value at Risk (VaR)-Cont’d


Tutorial Outline
➢ Solving on Value at Risk (VaR)
Problem 1:
Suppose a U.S.-based exporter sells goods to the Eurozone and
will receive €1 million in one month. The current EURUSD
exchange rate is 1.05. The company estimates that, over a one-
month period, the EURUSD exchange rate could fluctuate with a
standard deviation of 1.5%, whereas the interest rates could
fluctuate at 0.04%. The correlation between US interest rates and
exchange rate is -0.32. Calculate the 98% VaR.

Probability 90% 92% 95% 96% 98% 99%

Z-Value 1.645 1.75 1.96 2.05 2.33 2.58


Answer

Invested Invested Value at


Standard Z- RQN Exchange
RF amount amount risk
Deviation Value at 98% rate
€ $ $
Exchange
0.015 -2.33 -0.03495 -0.03434 (36,063.62)
Rate
1,000,000 1.05 1,050,000
Interest
0.0004 -2.33 -0.000932 -0.000931 (978.60)
Rate
Interest
Correlation Exchange Rates
Rates-US
Exchange Rates 1 -0.32
Interest Rates -0.32 1

Interest
Portfolio Exchange Rates
Rates
Exchange Rates 1300584498 -11293393.91
Interest Rates -11293393.91 957657.96

VaR portfolio $35,762.49


This is the maximum expected amount of loss in a
month at a probability of 98%
Practice Yourself !
Question 1:
1. What does Value at Risk (VaR) measure in the context of
exchange rate risk?

A) Expected profit from foreign exchange positions


B) The maximum loss over a target horizon at a given confidence
level
C) The average daily fluctuation in exchange rates
D) The standard deviation of exchange rate changes
Question 2:
2. If a bank calculates a 1-day VaR of $1 million for its foreign
exchange portfolio at a 95% confidence level, this means:

A) There is a 95% chance the bank will gain $1 million in a day.


B) The bank will not lose more than $1 million on any given day.
C) There is a 5% chance the bank will lose more than $1 million in
a day.
D) The bank will have a daily profit of $1 million with 95%
probability.
Question 3:
Which of the following is NOT an assumption of the VaR model?

A) Returns are normally distributed.


B) Market conditions are stable.
C) The time horizon is fixed.
D) Profits and losses are guaranteed.
Question 4:
What method of calculating VaR uses past exchange rate
movements to estimate potential losses?

A) Parametric VaR (Variance-Covariance)


B) Historical Simulation
C) Monte Carlo Simulation
D) Fundamental Analysis
Question 5:
The confidence level in a VaR calculation represents:

A) The probability that the calculated VaR will be accurate.


B) The likelihood that actual losses will exceed the VaR estimate.
C) The probability that losses will not exceed the VaR threshold.
D) The average loss expected in a given time period.
Question 6:
Which of the following is a disadvantage of using VaR for
exchange rate risk?

A) It provides a clear maximum potential loss.


B) VaR does not account for extreme tail risk.
C) It can be calculated in multiple ways.
D) VaR is always accurate for long-term risk analysis.
Question 7:
Monte Carlo simulation in VaR calculation for exchange rate risk
is best described as:

A) A method that calculates VaR using historical data without


assumptions.
B) A parametric approach assuming normal distribution.
C) A scenario-based simulation of random future exchange rate
paths.
D) A calculation of the average exchange rate over a certain
period.
Question 8:
Why might a company prefer to calculate VaR for its currency
portfolio?

A) To determine potential profit in the foreign exchange market.


B) To estimate maximum potential losses and adjust hedging
strategies.
C) To evaluate interest rate risks unrelated to foreign exchange.
D) To monitor regulatory requirements for loan portfolios.
Question Answer
1 B
2 C
3 D
4 B
5 C
6 B
7 C
8 B

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