Free Value-At-Risk Case Study Solution | Assignment Help

MBA Staff Writer
Written by Gary F. Smith
Publish Date: 2024-11-03

Harvard Case - Value-At-Risk

"Value-At-Risk" Harvard business case study is written by Sanjiv Das, Stephen Lynagh. It deals with the challenges in the field of Finance. The case study is 11 page(s) long and it was first published on : Jan 31, 1997

At Fern Fort University, we recommend that the investment committee of the endowment fund adopt a Value-at-Risk (VaR) model as a key component of their risk management framework. This will allow them to quantify and manage potential losses on their investment portfolio, leading to more informed and prudent investment decisions.

2. Background

This case study focuses on the investment committee of the endowment fund at Fern Fort University. The committee is tasked with managing the fund's assets to ensure long-term financial sustainability and support the university's mission. The committee faces a challenge in balancing the need for high returns with the need to protect the fund's principal from significant losses. The case study highlights the committee's current risk management practices, which are largely informal and based on intuition. The committee is considering adopting a more formal risk management approach, specifically a Value-at-Risk (VaR) model.

The main protagonists of the case study are the members of the investment committee, including the chair, a professor of finance, and the endowment fund manager. They are grappling with the decision of whether or not to adopt a VaR model and the potential impact it could have on their investment strategy.

3. Analysis of the Case Study

To analyze the case study, we can use a framework that considers both the financial and strategic aspects of risk management. This framework can be broken down into the following components:

  • Financial Analysis:

    • Risk Assessment: The committee needs to identify and quantify the various risks faced by the endowment fund, such as market risk, credit risk, and liquidity risk.
    • Return on Investment (ROI): The committee should assess the potential return on investment from adopting a VaR model, taking into account the costs associated with implementation and ongoing maintenance.
    • Cash Flow Management: The committee needs to understand the impact of potential losses on the endowment fund's cash flow and its ability to meet its financial obligations.
    • Financial Forecasting: The committee can use a VaR model to forecast potential losses under different market scenarios, which can inform their investment decisions.

  • Strategic Analysis:

    • Financial Strategy: The committee should develop a clear financial strategy that aligns with the university's mission and long-term goals. This strategy should consider the risk appetite of the university and its stakeholders.
    • Investment Management: The committee needs to develop a robust investment management process that incorporates risk management principles. This process should include a clear investment policy statement, portfolio diversification, and regular portfolio monitoring.
    • Corporate Governance: The committee should ensure that its risk management practices are aligned with best practices in corporate governance. This includes transparent reporting, accountability, and independent oversight.

4. Recommendations

The investment committee should adopt a Value-at-Risk (VaR) model as a key component of their risk management framework. This model should be implemented in the following stages:

  1. Define the Risk Appetite: The committee should clearly define the university's risk tolerance and establish acceptable levels of potential losses.
  2. Select a VaR Model: The committee should choose a VaR model that is appropriate for the size and complexity of the endowment fund. This could include a historical simulation model, a Monte Carlo simulation model, or a parametric model.
  3. Develop a Risk Management Policy: The committee should develop a comprehensive risk management policy that outlines the procedures for using the VaR model, including the frequency of VaR calculations, the reporting requirements, and the escalation process for significant deviations from the expected risk profile.
  4. Implement and Monitor the VaR Model: The committee should implement the chosen VaR model and monitor its performance regularly. This includes comparing the actual performance of the portfolio with the expected performance based on the VaR model.
  5. Review and Adjust the VaR Model: The committee should periodically review the VaR model to ensure its effectiveness and make adjustments as necessary, considering changes in market conditions, investment strategy, or the university's risk appetite.

5. Basis of Recommendations

The recommendation to adopt a VaR model is based on the following considerations:

  • Core Competencies and Consistency with Mission: The university's mission is to provide quality education and research. A well-managed endowment fund is essential for achieving this mission. Adopting a VaR model aligns with this mission by protecting the fund's principal and ensuring its long-term sustainability.
  • External Customers and Internal Clients: The endowment fund is a key source of funding for the university and its various programs. By adopting a VaR model, the committee can demonstrate its commitment to responsible investment practices and build trust with external stakeholders, such as donors and alumni.
  • Competitors: Many universities and other institutions have adopted VaR models to manage their investment portfolios. By adopting a similar approach, Fern Fort University can stay competitive and ensure that its endowment fund performs well relative to its peers.
  • Attractiveness ' Quantitative Measures: The VaR model can be used to quantify the potential losses associated with different investment strategies. This information can help the committee make more informed decisions and potentially improve the overall return on investment.

6. Conclusion

Adopting a Value-at-Risk (VaR) model is a prudent step for the investment committee of the endowment fund at Fern Fort University. By quantifying and managing potential losses, the committee can enhance its risk management framework, make more informed investment decisions, and ensure the long-term sustainability of the endowment fund.

7. Discussion

Other alternatives not selected include:

  • Continuing with current informal risk management practices: This approach carries a higher risk of significant losses and may not be sustainable in the long term.
  • Adopting a different risk management model: There are other risk management models available, such as scenario analysis or stress testing. However, a VaR model is widely accepted and considered a best practice for managing investment portfolios.

Key assumptions of the recommendation include:

  • The committee has the necessary resources and expertise to implement and maintain a VaR model.
  • The chosen VaR model is appropriate for the specific characteristics of the endowment fund.
  • The committee will regularly review and adjust the VaR model based on changing market conditions and investment strategy.

8. Next Steps

The following steps should be taken to implement the recommendation:

  • Timeline:
    • Month 1: Form a working group to research and evaluate different VaR models.
    • Month 2: Select a VaR model and develop a risk management policy.
    • Month 3: Implement the chosen VaR model and begin monitoring its performance.
    • Month 6: Review the performance of the VaR model and make any necessary adjustments.
  • Key Milestones:
    • Develop a clear definition of the university's risk tolerance.
    • Select a VaR model that meets the needs of the endowment fund.
    • Train the investment committee and staff on the use of the VaR model.
    • Establish a regular reporting process for monitoring the VaR model's performance.

By taking these steps, the investment committee can effectively implement a VaR model and improve the risk management of the endowment fund at Fern Fort University.

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Case Description

Introduces the student to the recently developed concept of value-at-risk (VAR) in risk analysis. By working through a stylized example using spreadsheet tools, the student learns the conceptual framework of VAR and its implementation mechanics.

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