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Answer: The actual returns, which correspond to the total return on the bank's trading portfolio, and the hypothetical returns, which represent the returns obtained from freezing the starting positions in the bank's trading portfolio
The correct answer for the question is B. The explanation provided in the file content states that the analyst should use both the actual and hypothetical returns for backtesting as they yield informative comparisons. Actual returns correspond to the total return on the bank's trading portfolio, while hypothetical returns represent the returns obtained from freezing the starting positions in the bank's trading portfolio. This approach allows the analyst to identify specific issues within the model. If the model passes backtesting with hypothetical but not actual returns, it indicates a problem with intraday trading. Conversely, if the model does not pass backtesting with hypothetical returns, it suggests that the modeling methodology should be re-examined. The other options (A, C, and D) are incorrect as they do not represent the appropriate sets of returns data for backtesting purposes as per the context provided in the file content.
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A financial analyst at LKS Bank is responsible for validating the bank's Value at Risk (VaR) model by employing the backtesting method. In this context, the analyst plans to use two different datasets of return information to compare the expected losses with the actual losses effectively. Which of the following options correctly represents the two most appropriate datasets of return information for the purpose of backtesting?
A
The cleaned returns, which are the actual returns minus any profit and loss from intraday trades, and the actual returns, which correspond to the total returns on the bank's trading portfolio
B
The actual returns, which correspond to the total return on the bank's trading portfolio, and the hypothetical returns, which represent the returns obtained from freezing the starting positions in the bank's trading portfolio
C
The hypothetical returns, which represent the returns obtained from freezing the starting positions in the bank's trading portfolio, and the cleaned returns, which are the actual returns minus any profit and loss from intraday trades
D
The trading returns, which are the actual returns minus any fees and commissions, and the hypothetical returns, which represent the actual returns obtained from freezing the starting positions in the bank's trading portfolio