Chartered Financial Analyst (CFA) Practice Exam Level 2

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What do incremental VAR calculations assess?

  1. Total value at risk

  2. Expected portfolio losses

  3. Changes in VAR from portfolio allocation shifts

  4. Market price fluctuations

The correct answer is: Changes in VAR from portfolio allocation shifts

Incremental Value at Risk (VAR) calculations specifically focus on assessing the change in VAR due to shifts in portfolio allocations. This involves analyzing how the risk of a portfolio is impacted when an investor makes changes to the weights of the assets within that portfolio. By understanding these changes, investors can make more informed decisions about how to optimize their investment strategies in light of their risk tolerances and return objectives. Incremental VAR is particularly useful for gauging how the addition or removal of an asset influences the overall risk profile, allowing for more precise risk management. This method is critical in portfolio management as it provides insight into the marginal contribution of each asset to the portfolio's overall risk, enabling better decision-making regarding asset allocation adjustments. The other options do not accurately capture the specific purpose of incremental VAR. Total value at risk focuses on the overall risk without the granularity provided by incremental analyses. Expected portfolio losses are more about forecasting loss outcomes, rather than the specific changes to risk generated by portfolio adjustments. Market price fluctuations relate to market movements, rather than the internal shifts in a portfolio's structure and their effects on VAR.

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