Answer: USD2.55 million

The question is asking for the new estimate of the 10-day 99% Value at Risk (VaR) for an equally weighted, two-asset portfolio after the correlation between the two assets doubles. The initial conditions are given: the volatility of daily returns for each asset is 2%, the portfolio value is USD 20 million, and the 10-day 99% VaR is USD 2.33 million. The explanation provided in the file content uses the formula for the variance of the portfolio return, which is a function of the individual volatilities of the assets and the correlation between them. The initial variance (g²) is calculated using the weights (W1 and W2) and the correlation (ρ12). The initial 1-day VaR is then estimated using the formula Za * σp * Vp, where Za is the z-score corresponding to the 99% confidence level, σp is the standard deviation of the portfolio return, and Vp is the portfolio value. This 1-day VaR is scaled up to estimate the 10-day VaR. By working backward from the given 10-day VaR, the initial correlation (ρ12) is determined to be 0.2547. When the correlation doubles, the new correlation becomes 0.51. The new variance of the portfolio is then recalculated using the new correlation value. The correct answer is B, USD 2.55 million, which is derived by recalculating the 10-day VaR with the new portfolio variance and the given portfolio value and z-score. This result is obtained by adjusting the initial VaR calculation to reflect the increased correlation between the assets, which affects the portfolio's risk profile and, consequently, its VaR.

Author: LeetQuiz Editorial Team