Question10 At 1-percent adverse market movement scenario, the DEAR of the trading portfolio of Elite Bank is estimated as $20 million. This means: Select one alternative: a. There is a 99% probability that the bank will lose $20 million or less over the next day. b. There is a 99% probability that the bank will lose less than $20 million over the next day. c. There is a 1% probability that the bank will lose $20 million or more over the next year. d. There is a 1% probability that the bank will lose $20 million or less over the next day. e. There is a 1% probability that the bank will lose $20 million over the next day. ResetMaximum marks: 2 Flag question undefined

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BlackTom AI · Accepted Answer

Question restatement: The problem states that the DEAR (Daily Earnings at Risk) of Elite Bank’s trading portfolio at a 1-percent adverse market movement scenario is $20 million, and asks for the correct interpretation of this figure.

Option a: 'There is a 99% probability that the bank will lose $20 million or less over the next day.' This aligns with the standard interpretation of a 1-percent risk metric like VaR or DEAR: with 99% confidence, losses will not exceed the $20 million threshold on the next day. In other words, the 1% tail loss threshold corresponds to losses up to $20 million for 99% of outcomes. This option correctly captures the notion of a 1% adverse movement.

Option b: 'There is a 99% probability that the bank will lose less than $20 million over the next day.' The nuance here is the word 'less than.' In risk terms, we typically interpret the threshold as 'less than or equal to' the specified amount. Excluding the equality could be considered a minor precision issue, but most definitions treat it as inclusive, so this answer is not correctly or precisely stated.

Option c: 'There is a 1% probability that the bank will lose $20 million or more over the next year.' This misplaces both the probability (1% vs 99%) and the time horizon (next year vs next day). DEAR at 1% pertains to a one-day horizon, not a year, and the probability framing is inverted.

Option d: 'There is a 1% probability that the bank will lose $20 million or less over the next day.' A 1% probability of losing at most $20 million would imply a much smaller tail risk, not the typical DEAR interpretation. It contradicts the standard VaR/DEAR concept, which relates the threshold to the probability of exceeding that loss, not staying below it.

Option e: 'There is a 1% probability that the bank will lose $20 million over the next day.' This statement ignores the framing of threshold in terms of a risk bound (the 1% tail corresponds to losses up to that threshold for 99% of outcomes), not a sole occurrence probability. It also omits the contextual comparison to the rest of the distribution and the 99% confidence level.

Summary of reasoning: The conventional interpretation of a 1-percent DEAR (or VaR) figure is that the loss threshold of $20 million is exceeded with 1% probability, or equivalently, there is a 99% probability that losses will be at or below $20 million on the next day. Among the options, this is most accurately captured by option a, with the understanding that the threshold is inclusive of the loss amount (i.e., '$20 million or less').

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