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Dear John,
I have seen your lecture on value at risk but while doing 18. Jonas Chemical System, BPP Revision Kit i am stuck in part b) i.
Can you please explain how they calculate standard deviation 1.9265 and project probability of 97.3% and value at risk formulla components applies in this answer..How the examiner got 3.612 figure whie calculating project value at risk ?
I will explain the second part of your question first 🙂
The standard deviation per year is 1.02. However, we need the std devn for 10 years.
We can’t multiply the SD by 10, instead we need to multiply the variance (SD^2) by 10.
So the (10 year SD)^2 = 10 x 1.02^2
So the 10 year SD = (sq root of 10) x 1.02 = 3.162 x 1.02
This bit I do in fact explain in my lecture.
(and then we multiply by 1.645 because we want 95% confidence).With regard to your first question, we are effectively doing it ‘backwards’.
Whereas for 95% confidence we use the tables and find it is 1.645 SD’s; here we know how many SD’s there are (1.9255) and so we look in the tables and this has a probability of about 0.473 (we cannot look up 1.9255 so we use 1.93 as the nearest). Add on 0.5 and we have 0.973 or 97.3%Thank you so much John, you gave me the exact reason which i was looking for and solve my great problem.
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