Financial Risk Manager Part 1

Explanation

Historical volatility measures the standard deviation of past price movements over a specific time period. It is calculated from historical price data and reflects how much an asset's price has fluctuated in the past.

Implied volatility is derived from option prices using models like Black-Scholes. It represents the market's expectation of future volatility - essentially what the market 'implies' the volatility will be over the life of the option.

Why option A is correct:

• It accurately states that historical volatility measures past price movements (standard deviation)
• It correctly describes implied volatility as an estimate of future volatility
• The wording "gives an estimate" is appropriate since implied volatility is forward-looking and based on market expectations

Why other options are incorrect:

• Option B: Incorrect because implied volatility is measurable (derived from option prices) and not "immeasurable"
• Option C: Inaccurate because historical volatility measures past volatility, not "volatility recorded as at present"
• Option D: Incorrect because implied volatility is not about "historical volatility beyond a given benchmark" but rather future expectations

Key differences:

1. Time orientation: Historical looks backward, implied looks forward
2. Calculation: Historical uses actual price data, implied uses option prices and models
3. Purpose: Historical shows what happened, implied shows what the market expects
4. Use in trading: Historical helps assess risk, implied helps price options and gauge market sentiment