Explanation:
First, calculate the Normal VaR. Position Value = 10,000 shares × ₹200 = ₹2,000,000. Normal VaR = Position Value × Z × Volatility = ₹2,000,000 × 2.33 (for 99% confidence level) × 0.02 = ₹93,200. Next, calculate the liquidity cost using the constant spread approach. Liquidity Cost = 0.5 × Spread × Number of Shares = 0.5 × ₹0.80 × 10,000 = ₹4,000. Liquidity-Adjusted VaR = Normal VaR + Liquidity Cost = ₹93,200 + ₹4,000 = ₹97,200.
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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:
A
₹97,200
B
₹4,000
C
₹86,500
D
₹65,800
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