Consider a portfolio consisting of $ 10 million invested in the S&P 500 and $ 7.5 million invested in U.S treasury bonds. The S&P 500 has an expected return of 14% and a standard deviation of 16%. The treasury bonds have an expected return of 9% and a standard deviation of 8%. The correlation between the S&P 500 and Bonds is 0.35. All figures are stated on an annual basis. Find the VAR for one year at a probability of 5%. Identify and use the most appropriate method given the information you have. Using the information, you obtained in part a, find VAR for one day.
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Consider a portfolio consisting of $ 10 million invested in the S&P 500 and $ 7.5 million invested in U.S treasury bonds. The S&P 500 has an expected return of 14% and a standard deviation of 16%. The treasury bonds have an expected return of 9% and a standard deviation of 8%. The correlation between the S&P 500 and Bonds is 0.35. All figures are stated on an annual basis.
- Find the VAR for one year at a probability of 5%. Identify and use the most appropriate method given the information you have.
- Using the information, you obtained in part a, find VAR for one day.
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