How to Interpret a 5% 3-month Value At Risk (VaR) of $1 million

What does a 5% 3-month Value At Risk (VaR) of $1 million represent?

Choose the correct option:

A. A 5% chance of the asset increasing in value by $1 million during the 3-month time frame.

B. The likelihood of a 5% of $1 million decline in the asset over the next 3-month.

C. A 5% chance of the asset declining in value by $1 million during the 3-month time frame.

D. A 5% decline in the value of the asset after 3 months, per each $1 million of notional.

Answer:

A 5% 3-month Value At Risk (VaR) of $1 million represents a 5% chance of the asset declining in value by $1 million during the 3-month time frame.

Value At Risk (VaR) is a statistical measure that calculates the potential loss in value of an asset or portfolio over a specific time period with a certain level of confidence. A 5% 3-month VaR indicates that there is a 5% probability that the asset or portfolio will lose at least $1 million in value over the next three months. This means that there is a 95% probability that the asset or portfolio will not lose more than $1 million in value during the 3-month period.

The other options - a 5% chance of the asset increasing in value by $1 million during the 3-month time frame, a 5% decline in the value of the asset after 3 months, per each $1 million of notional - do not accurately represent what a 5% 3-month VaR of $1 million means.