Chartered Financial Analyst (CFA) Practice Exam Level 2

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What does the term 'CVAR' relate to?

  1. Total value lost

  2. Portfolio's expected shortfall

  3. Standard deviation of returns

  4. Asset allocation efficiency

The correct answer is: Portfolio's expected shortfall

The term 'CVAR' refers to Conditional Value at Risk, which specifically relates to a portfolio's expected shortfall. CVAR measures the average loss that can occur beyond the Value at Risk (VaR) threshold in a given time frame, effectively capturing the tail risk in the distribution of returns. It provides insight into the potential losses in extreme market conditions, making it a crucial risk management tool for assessing the risk profile of portfolios. In finance, understanding the expected shortfall is critical for risk management as it allows investors to grasp not just the likelihood of extreme losses, but also the magnitude of those losses if the VaR threshold is breached. This makes CVAR a vital metric for investors and portfolio managers in making informed decisions based on their risk tolerance and investment strategies. Elements like total value lost, standard deviation of returns, and asset allocation efficiency do not fully encompass the specific risk assessment that CVAR provides, particularly in the context of tail risk and extreme loss scenarios.

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