Business

Subject name

Corporate Finance

Prepared by

M.Numan Naeem

Class

BBA (Hons)7th (Evening, B section)

Roll number

9392

Submitted to

Sir Waqas Safdar

Department

Business Administration

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Government College University Faisalabad

The Idea behind Value at Risk (VAR)

The most popular and traditional measure of risk is volatility. The main problem with volatility, however, is that it does not care about the direction of an investment's movement: a stock can be volatile because it suddenly jumps higher. Of course, investors are not distressed by gains!

For investors, risk is about the odds of losing money, and VAR is based on that common-sense fact. By assuming investors care about the odds of a really big loss, VAR answers the question, "What is my worst-case scenario?" or "How much could I lose in a really bad month?"

Now let's get specific. A VAR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage). Keep these three parts in mind as we give some examples of variations of the question that VAR answers:

* What is the most I can - with a 95% or 99% level of confidence - expect to lose in dollars over the next month?

* What is the maximum percentage I can - with 95% or 99% confidence - expect to lose over the next year?

You can see how the "VAR question" has three elements: a relatively high level of confidence (typically either 95% or 99%), a time period (a day, a month or a year) and an estimate of investment loss (expressed either in dollar or percentage terms).

Methods of Calculating VAR

Institutional investors use VAR to evaluate portfolio risk, but in this introduction we will use it to evaluate the risk of a single index that trades like a stock: the Nasdaq 100 Index, which trades under the ticker QQQQ. The QQQQ is a very popular index of the largest non-financial stocks that trade...