AIN 3220: Investment and Risk Analysis

Chapter 2: Risk Measures

Practice Problems

1. Assume that Portfolio A, measured in unit of millions, has the following loss dis-
tribution:

-$10 pA (−$10) = 0.92,

A
L = $ 10 pA ($10) = 0.06, (0.1)

$20 pA ($20) = 0.02.


Consider a multipler c = 2, and define a new portfolio Ā = 2A.

(a) Using Semi-Variance as the risk measure, calculate the Semi-variance of the
loss in Portfolio Ā.
(b) Show that the positive homogeneity property does not hold when the Semi-
variance is used as the risk measure.

2. Consider Portfolio A in the last problem and denote a new portfolio à by adding
cash K = $5 million.

(a) Using Semi-Variance as the risk measure, calculate the Semi-variance of the
loss in Portfolio Ã.
(b) Show that the cash invariance property does not hold when the Semi-variance
is used as the risk measure.

3. What is the difference between expected shortfall and V@R? What is the theoretical
advantage of expected shortfall over V@R?

4. A fund manager announces that the fund’s one month 95%V @R is 6% of the size
of the portfolio being managed. You have an investment of $100, 000 in the fund.
How do you interpret the portfolio manager’s announcement?

5. A fund manager announces that the fund’s one month 95% expected shortfall is 6%
of the size of the portfolio being managed. You have an investment of $100, 000 in
the fund. How do you interpret the portfolio manager’s announcement?

6. Suppose that each of two investments has a 0.9% chance of a loss of $10 million
and 99.1% chance of a loss of $1 million. The investments are independent of each
other

(a) What is the V @R for one of the investments when the confidence level is 99%?
(b) What is the expected shortfall for one of the investments when the confidence
level is 99%?
(c) What is the V @R for a portfolio consisting of the two investments when the
confidence level is 99%?

1
 (d) What is the expected shortfall for a portfolio consisting of the two investments
when the confidence level is 99%?
(e) Show that in this example V @R does not satisfy the subaddivity condition,
whereas expected shortfall does.

7. An investment has a 85% chance of leading a gain of $2 million, a 5% chance of

incurring a loss of $2 million and a 4% chance of incurring a loss of $4 million, a 3%
chance of incurring a loss of $6 million, 3% chance of incurring a loss of $8 million.
Find 96%V @R of this investment.

8. An investment has a 85% chance of leading a gain of $2 million, a 5% chance of

incurring a loss of $2 million and a 4% chance of incurring a loss of $6 million, a 3%
chance of incurring a loss of $6 million, 3% chance of incurring a loss of $8 million.
Find 96% Expected Shortfall of this investment.