Explanation:
The difference in VaR values for duration mapping and cash flow mapping is due to two factors. The first factor is that risk measures are not perfectly linear with maturity. This means that as the maturity of the bond increases, the risk does not increase at a constant rate. Instead, it may increase at a decreasing rate, remain constant, or even decrease. The second factor is that correlations are below unity. In finance, correlation is a statistical measure that indicates the extent to which two or more variables move in relation to each other. A correlation below unity (less than 1) means that the variables do not move perfectly in sync with each other. This reduces the overall risk of the portfolio because the negative performance of one bond may be offset by the positive performance of the other bond. Therefore, both these factors contribute to the difference in VaR values for duration mapping and cash flow mapping.
Choice B is incorrect. The assertion that risk measures are perfectly linear with maturity and correlations are below unity does not explain the difference in VaR values between duration mapping and cash flow mapping. In reality, risk measures are not perfectly linear with maturity,
Ultimate access to all questions.
No comments yet.
Q.1516 Considering an example of a two-bond portfolio, we calculated the portfolio returns and the risks associated with those portfolios using the mapping technique. Then, we found some specific values, say, 2.80 VaR for duration mapping and 2.67 VaR for cash flow mapping. This notable difference in these values is due to the fact that:
A
risk measures are not perfectly linear with maturity and correlations are below unity.
B
risk measures are perfectly linear with maturity and correlations are below unity.
C
risk measures are perfectly linear with maturity and correlations are above unity.
D
risk measures are not perfectly linear with maturity and correlations are equal to unity.