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Explanation:
If the correlation between two assets is zero, then the portfolio VaR is given by the square root of the sum of the squared individual VaRs. i.e
A correlation of -1 indicates a perfect negative correlation between corporate and Treasury bonds. A correlation of -1 normally implies that the assets move in opposite directions, which can potentially provide some level of diversification. In this case, however, since the hedge fund comprises $1 billion long corporate bonds and short in Treasury bonds, there are no diversification benefits, and as such, risk is amplified.
Note that the portfolio VaR equals the undiversified VaR (the sum of individual VaRs) only if the correlations are unity, and that short sales are not allowed.
Correlation measures the degree to which two assets move in relation to each other. A correlation of -1 indicates a perfect negative correlation, 0 indicates no correlation, and +1 indicates a perfect positive correlation.
Portfolio VaR is the measure of potential loss in the value of a portfolio over a specified time horizon for a given confidence level. It takes into account the individual VaRs of the assets in the portfolio as well as their correlations.
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Q.2462 Consider a hedge fund which is $1 billion long in corporate bonds and $1 billion short in Treasury bonds. Which of the following statements is (are) correct?
I. If zero correlation exists between corporate and treasury bonds, then the portfolio VaR is zero
II. If the correlation between corporate and Treasury bonds is equal to -1, the risk will be amplified
A
Only I
B
Only II
C
Both I and II
D
Neither I nor II