Using of VaR to manage Investment Risk (Measuring of Investment Risk)

VaR measures some level of potential losses. It suggests the maximum Rupee value of losses a bank may experience on its investment for a specific level of confidence lever over a specific time. VaR is determined for each class of assets, for each stock in case of Equity Portfolio, and is helpful in capital allocation decision with respect to investing in a particular asset class, such as in a stock. There is empirical evidences that whenever there is change in particular position in a portfolio, i.e. additional investment in a particular stock, the VaR of the Portfolio changes. It has always been a point of concern for Fund Manager of having an assessment about effects of adding or subtracting positions from an investment portfolio i.e. change in VaR due to additional investment in a particular asset i.e. in a stock in case of Equity Portfolio. This is technically known as Marginal VaR and defined as additional amount of risk that a new investment position adds to a portfolio. Formula to calculate marginal VaR is as under:

 

Marginal VaR = (VaR_Portfolio / Portfolio Value) * Beta _{(Particular assets)}

 

Suppose that a bank has an Equity Portfolio consists of four stocks, named A, B, C & D. Further suppose that VaR of the Portfolio is Rs.400,000. Investment in each stock is equally weighted such as Rs.1,000,000. Therefore, total portfolio value is Rs.4,000,000. The Fund Manager of the Bank has identified an opportunity of excess return by investing in Stock “A”, however, is concerned with that how Portfolio VaR will change due to additional investment in Stock “A”.

 

Q6a/7             Calculate Marginal VaR of Stock “A”, when beta of Stock “A” is 1.2

Q6b/3             What does the result suggest?

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Q6a7 Calculation of Marginal VaR of Stock A formula Marginal VaR VaRPort... View the full answer