A risk manager at a distressed debt hedge fund is comparing the credit risk of the fund's investments of GBP 20 million each in two corporate bonds, Bond F and Bond G. The manager models credit losses on the bonds as discrete random variables and makes the following assumptions about their probability distributions:

Bond F: There is a 1% chance that it will suffer a loss of at least GBP 10 million, but a 0.8% chance it will suffer a loss of the entire GBP 20 million investment.

Bond G: There is a 1% chance that it will suffer a loss of at least GBP 10 million, but a 0.9% chance it will suffer a loss of between GBP 10 million and GBP 17.5 million, with a loss of more than GBP 17.5 million not considered possible.

Assuming the loss distributions for the two bonds are the same for all losses below the 99 percentile point, which of the following would the manager be correct to conclude?

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The 99% VaR measure is the most effective risk measure for comparing the relative riskiness of the bonds.

The 99% VaR measure cannot be used in this case, as losses must be assumed to follow a normal distribution to estimate VaR.

The 99% VaRs of the bonds differ, which accurately represents the bonds as having different levels of risk.

The 99% VaRs of the bonds are equal, which fails to reflect the fact that the bonds have different levels of risk.

Financial Risk Manager Part 1