Answer-first summary for fast verification
Answer: The delta-normal model assumes that the 1-day change in the value of the call option is normally distributed.
**Correct Answer: D** **Explanation:** D is correct. The delta-normal model assumes that the change in the value of a portfolio is normal, making it easy to calculate VaR as a function of the standard deviation and (under some circumstances) the mean of changes in portfolio value. A is incorrect. While the two positions have the same underlying asset, the option position (being nearly at-the-money) has a delta with respect to the price of the underlying that is fairly close to 0.5, while the futures position has a delta with respect to the price of the underlying equal to 1. Therefore, the VaRs will not be equal. B is incorrect. A common assumption is that the mean change in each risk factor is zero. The assumption is not exactly true, but it is reasonable when considering short time periods (because the mean change in the value of a portfolio is much less than its standard deviation during a short time period). C is incorrect. The price of the call option has a nonlinear relationship with the price of the underlying. As the price of the contract decreases, delta will decrease as well, so VaR will decrease at a non-linear rate.
Author: LeetQuiz .
Ultimate access to all questions.
A risk manager is evaluating the impact of using the delta-normal model in calculating VaR for the following two positions:
The current spot price of WTI is USD 84.50 per barrel. In assessing the 1-day 95% VaR of the two positions, which of the following is correct?
A
The VaR of the futures position is equal to the VaR of the call option position.
B
It would be inappropriate to assume that the expected value of the daily change in the WTI spot price is zero.
C
As the spot price of WTI decreases, the VaR of the call option will decrease in a linear fashion.
D
The delta-normal model assumes that the 1-day change in the value of the call option is normally distributed.
No comments yet.