Page 187 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes  Value at Risk (VaR) is a market risk measurement approach that uses historical market
trends and volatilities to estimate the likelihood that a given portfolio's losses will exceed
a certain amount.
 VAR is a statistical methodology that helps risk managers to aggregate risk numbers
across business and product lines in a meaningful way.

 Historical simulations represent the simplest way of estimating the Value at Risk for
many portfolios.
 In this approach, the VaR for a portfolio is estimated by creating a hypothetical time
series of returns on that portfolio, obtained by running the portfolio through actual
historical data and computing the changes that would have occurred in each
period.
 Variability in a security's total returns that is directly associated with overall movements
in the general market or economy is called systematic (market) risk.
 The variability in a security's total returns not related to overall market variability is
called the non-systematic (non-market) risk.

13.6 Keywords

Historical Simulations: Historical simulations represent the simplest way of estimating the
Value at Risk for many portfolios.
Non-systematic (non-market) Risk: The variability in a security's total returns not related to
overall market variability is called the non-systematic (non-market) risk.
Stock Index Futures: A stock index futures contract is a contract to buy or sell the face value of the
underlying stock index where the face value is defined as being the value of index multiplied by
the specified monetary amount.

Systematic (Market) Risk: Variability in a security's total returns that is directly associated
with overall movements in the general market or economy is called systematic (market)
risk.

Value at Risk (VaR): Value at Risk (VaR) is a market risk measurement approach that uses
historical market trends and volatilities to estimate the likelihood that a given portfolio's losses
will exceed a certain amount.

13.7 Review Questions

1. Define index options. How index options are different from equity options?
2. Discuss the evolution of index futures.
3. How will you price a index future.

4. "Value at Risk (VaR) is a market risk measurement approach that uses historical market
trends and volatilities to estimate the likelihood that a given portfolio's losses will exceed
a certain amount." Discuss.
5. Historical simulations represent the simplest way of estimating the Value at Risk for
many portfolios. Discuss.
6. Distinguish between systematic and non-systematic risk.

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