The analysts at ABC Plc use a two-step process to manage the assets and risk in their portfolio. First, they use a Value at Risk (VaR)-based risk budgeting process to determine the asset allocation across four broad asset classes. Then, within each asset class, they set a maximum tracking error allowance from a benchmark index and determine an active risk budget to distribute among individual managers. Assume the returns are all normally distributed. From the first step in the process, the following information is available.

Expected Return %

Standard Deviation %

Asset Allocation %

Individual VaR

Marginal VaR

Small-cap

0.20

2.66

35.0

-6,491

-0.055

Large-cap

0.15

2.33

40.0

-6,497

-0.044

Commodities

0.10

1.91

16.7

-2,216

-0.020

Emerging markets

0.15

2.70

8.3

-1,570

-0.047

Total VaR: -13,322

Which of the following statements is/are correct?

I. Using Value at Risk as the risk budgeting measure, the emerging markets class has the smallest risk budget.

II. If an additional pound were added to the portfolio, the marginal impact on portfolio Value at Risk would be greatest if it were invested in small caps.

III. As the maximum tracking error allowance is lowered, the individual managers have more freedom to achieve greater excess returns.

IV. Setting well-defined risk limits and closely monitoring risk levels guarantee that risk limits will not be exceeded.

Question 8 options:

II and III.

None of the other answers.

I, II, III, and IV.

I and II only.

I only.