Which of the following statements regarding the measurement of risk for non-linear derivatives is (are) true?
I.A disadvantage of the delta-normal approach is that it is highly computational.
II.The full r*uation approach is most appropriate for portfolios containing mortgage backed securities or options with embedded features.
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
Answer: D
Both the delta-normal and full r*uation methods measure the risk of nonlinear securities. The full r*uation approach calculates the VaR of the derivative by valuing the derivative based on the underlying value of the index after the decline corresponding to an x% VaR of the index. This approach is accurate, but can be highly computational; therefore, it does not work will for portfolios of more complex derivatives such as mortgage-backed securities, swaptions, or options with embedded features. The delta-normal approach calculates the risk using the delta approximation, which is linear or the delta-gamma approximation, which adjusts for the curvature of the underlying relationship. This approach simplifies the calculation of more complex securities by approximating the changes.