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Answer: The risk of the portfolio will have been understated because of the incorrect estimate of correlation among global markets.
## Explanation When the portfolio manager adjusts correlations upward in VaR analysis but the actual correlations turn out to be lower: - **VaR is calculated based on correlation assumptions**: Higher correlations increase portfolio VaR because assets move more closely together, reducing diversification benefits. - **If actual correlations are lower**: The portfolio is actually more diversified than assumed, meaning the actual risk is lower than what was estimated. - **Result**: The risk was **understated** in the VaR calculation because the manager used higher correlations than reality, which would have led to a higher VaR estimate, but the actual risk was lower. **Key reasoning**: - Manager expects higher correlations → adjusts VaR upward - If actual correlations are lower → true portfolio risk is lower than estimated - Therefore, the VaR **underestimated** the actual risk level - The risk was **understated** This matches option C: "The risk of the portfolio will have been understated because of the incorrect estimate of correlation among global markets."
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A portfolio manager, believing that globalization is causing the correlations of equity and fixed-income returns across different markets to rise over time, decides to adjust the correlations in his VaR analysis for the coming year to reflect the higher correlations he expects. If his expectation turns out to be incorrect, what is the most likely result?
A
There will be no impact on the portfolio because VaR is only a prediction, and portfolio return depends on what actually happens.
B
The portfolio return will be lower than it should have been, given the expected risk level, because asset allocation will not have been optimal.
C
The risk of the portfolio will have been understated because of the incorrect estimate of correlation among global markets.
D
The portfolio return will be higher than it should have been, given the expected risk level, because of the higher correlation among asset classes
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