Liquidity Adjusted VAR

[nitin3000]

A trader observes a quote for stock DUY, and the midpoint of its current best bid and best ask prices is CAD 45. DUY has an estimated daily return volatility of 0.38% and average bid-ask spread of CAD 0.14. Using the constant spread approach on a 20,000 share position and assuming the returns of DUY are normally distributed, what is closest to the estimated liquidity-adjusted, 1-day 95% VAR.

a. CAD 1600
b. CAD 5600
c. CAD 6600
d. CAD 7600

This questions from the 2016 FRM part 2 sample question paper.

 

[David Harper CFA FRM]

@nitin3000 this question has been analyzed in the (paid member) thread at https://forum.bionicturtle.com/threads/garp-2016-p2-19.10335/ where I commented:

"I think we determined this was a mistake (it was reported to GARP) in the practice exam and, as I wrote, the liquidity cost (LC) should be 0.5*CAD 0.140*20,000 shares = $1,400; or 0.5*(0.140/45.00) * (20,000 * 45.00) = $1,400. Thanks"