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Understanding VaR and CaR in Finance

The document explains Value at Risk (VaR) and Cash at Risk (CaR) as measures of potential financial loss and cash flow shortfall, respectively, highlighting their applications in different financial contexts. It also discusses back testing and stress testing as methods for evaluating financial strategies and assessing risk under extreme scenarios. Additionally, it covers Asset-Liability Management (ALM) as a process for balancing assets and liabilities to control various risks and ensure liquidity.

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14 views9 pages

Understanding VaR and CaR in Finance

The document explains Value at Risk (VaR) and Cash at Risk (CaR) as measures of potential financial loss and cash flow shortfall, respectively, highlighting their applications in different financial contexts. It also discusses back testing and stress testing as methods for evaluating financial strategies and assessing risk under extreme scenarios. Additionally, it covers Asset-Liability Management (ALM) as a process for balancing assets and liabilities to control various risks and ensure liquidity.

Uploaded by

arunkumar452869
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd

Value at Risk

VaR
Value at Risk (VaR) tells us how much money we could lose, over a
certain period of time, with a given level of confidence.

Example:
You invest ₹1,00,000 in a stock
Based on past data:
95% VaR for 1 day = ₹3,000
CaR
Cash at Risk (CaR) measures the maximum possible shortfall in cash
flow over a given time period, at a given confidence level.

Example:
A company expects ₹10 crore cash inflow next month from exports
Due to exchange rate fluctuations

There is a 95% chance that the company’s cash inflow will not fall by
more than ₹1 crore next month.
Value at Risk (VaR) Cash at Risk (CaR)

Potential shortfall in cash


What it measures Potential loss in value
flow

Focus Market value of assets Actual cash inflows/outflows

Used by Banks, traders, investors Companies, CFOs, treasury

Main risk Market risk (price changes) Liquidity risk

Salary / export cash not


Example Portfolio loss
received

Typical horizon Very short (1 day, 10 days) Monthly, quarterly, yearly

Concerned with Profit & portfolio value Ability to pay expenses


Back Testing
Back testing is the process of evaluating a strategy or model by applying
it to historical data to assess its past performance.

Refer: Charts for clear example


Stress Testing
Stress testing is a risk management technique used to evaluate the impact
of extreme but plausible adverse scenarios on a financial position. It helps
institutions assess their ability to withstand severe shocks and prepare for
crisis situations.

Stress testing helps to:


• Understand worst-case losses
• Check financial strength
• Prepare for crisis situations
• Improve contingency planning
Asset Liability Management
Asset–Liability Management is a financial management process that
coordinates the management of assets and liabilities to control risk,
ensure liquidity, and maintain financial stability.

It’s basically:
Balancing what comes in and what goes out.
Assets: Long-term loans (home loans, education loans)
Liabilities: Short-term deposits (savings, fixed deposits)

Depositors may withdraw money before loan repayments come in.

The bank plans maturities so it always has enough cash to meet


withdrawals.
Risks Managed In ALM
• INTEREST RATE RISK
• LIQUIDITY RISK
• MATURITY RISK
• CURRENCY RISK

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