Explanation:
Let's analyze each option:
Option A: CORRECT
Option B: INCORRECT
Option C: INCORRECT
Option D: INCORRECT
Therefore, only Option A correctly describes a limitation of the principal mapping approach.
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An analyst at a fixed-income investment company is evaluating different ways the company uses to estimate the VaR of its corporate bond portfolios. The portfolios consist of a large number of bonds with a wide range of maturities. The analyst examines the possibility of using a mapping approach to simplify the estimation process. Which of the following statements would the analyst be correct to make regarding the approaches to mapping fixed-income portfolios?
A
The VaR estimated using the principal mapping approach understates the true risk of a portfolio since it ignores coupon payments and any risk associated with them.
B
The VaR estimated using the duration mapping approach replaces the portfolio with a zero-coupon bond whose maturity equals the duration of the portfolio.
C
The VaR estimated using the principal mapping approach differs from the undiversified VaR estimated using the duration mapping approach due to an adjustment made for correlations.
D
The VaR estimated using the cash-flow mapping approach is less accurate than the VaR estimated using the duration mapping approach since it does not account for the timing of cash flows.