Question

VAR Measures the potential maximum 1-day loss on the value of positions of an MNC that is exposed to exchange rate movements.

Basically, it goes to compute how much is the maximum possible loss of MNC going to be if exchange rates move against the firm position.

In Calculating the Value at Risk (VAR), what is the implication of underestimating volatility of exchange rates? ( Please respond in a complete and explanatory way ) Answer should have 100 words minimum

Answer 1

Value at risk model will be helpful in determination of level of financial risk when the multinational corporation is exposed to the exchange rate movement. When it is underestimating the volatility in respect to overall global market, then it can lead to high risk exposure for the company in relation to the exchange rate movements and it will be also mean that there will be imperfect and improper hedging techniques which will be adopted by the multinational corporation in respect to managing the risk

it will also expose the multinational corporation to high correlation risk because these exchange rate movements will not just impacting the overall transaction exposure but it will also impact the overall economic exposure of the company if the volatility has not been properly estimated in advance so value-at-risk will be higher and it will be leading to a high risk associated with hedging of various transactions and it would be also leading to loss related to inadequate hedging technique so there is a proper need for adaptation of estimation of volatility in advance in order to nullify the impact of adverse movement in exchange rate markets.