Financial Risk Manager Part 2

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Explanation:

To calculate the Liquidity-Adjusted VaR (LVaR) using the constant spread approach, we first determine the standard VaR and then add the cost of liquidity.

Position Value: 10,000 shares × ₹200 = ₹2,000,000
Standard VaR: Using the 99% confidence level (z ≈ 2.33), VaR = Position Value × Volatility × z VaR = ₹2,000,000 × 0.02 × 2.33 = ₹93,200
Liquidity Cost: Under the constant spread approach, the cost is half the spread multiplied by the number of shares. Liquidity Cost = (Spread / 2) × Shares = (₹0.80 / 2) × 10,000 = ₹4,000
Liquidity-Adjusted VaR (LVaR): LVaR = VaR + Liquidity Cost = ₹93,200 + ₹4,000 = ₹97,200.

Hence, the LVaR is closest to ₹97,200.

Q.50 Samir Khan, FRM, is a manager of a renowned hedge fund. He is analyzing a 10,000-share position in an undervalued but illiquid stock - XYZ. The stock is currently trading at a price of ₹200 (expressed as the midpoint of the current bid-ask spread). XYZ’s daily return has an estimated volatility of 2%. The average bid-ask spread is ₹0.80. Assuming returns are normally distributed, the estimated liquidity-adjusted daily 99% VAR, using the constant spread approach, is closest to:

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₹97,200

₹4,000

₹86,500

₹65,800

Financial Risk Manager Part 2

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