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Risk Management Solution To Chapter 15

This document contains calculations of value-at-risk (VAR) for various financial positions including bonds, foreign exchange, equities, and a portfolio. It shows how to calculate the dollar equivalent amount of risk (DEAR) for each position based on factors like maturity, yield volatility, price volatility, and correlation between asset classes. The portfolio VAR is calculated as the square root of the sum of the squared DEAR values for each asset class plus their covariances.

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265 views

Risk Management Solution To Chapter 15

This document contains calculations of value-at-risk (VAR) for various financial positions including bonds, foreign exchange, equities, and a portfolio. It shows how to calculate the dollar equivalent amount of risk (DEAR) for each position based on factors like maturity, yield volatility, price volatility, and correlation between asset classes. The portfolio VAR is calculated as the square root of the sum of the squared DEAR values for each asset class plus their covariances.

Uploaded by

Bombita
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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4.

a. MD = D/(1 + R) = 5/(1.07) = 4.6729 years

b. Potential adverse move in yield at 1 percent = 2.33σ = 2.33 x 0.0012 = 0.002796

c. Price volatility = MD x potential adverse move in yield


= 4.6729 x 0.002796 = 0.013065 or 1.3065 percent

d. DEAR = ($ market value of position) x (price volatility)


= $1,000,000 x 0.013065 = $13,065

6.

For the 10-day period: VAR = 8,500 x [10]½ = 8,500 x 3.1623 = $26,879
For the 20-day period: VAR = 8,500 x [20]½ = 8,500 x 4.4721 = $38,013

The reason that 20-day VAR ≠ (2 x 10-day VAR) is because [20]½ ≠ (2 x [10]½). The
interpretation is that the daily effects of an adverse event become less as time moves farther
away from the event.

7.

a. If yield changes are normally distributed, 98 percent of the area of a normal distribution
will be 2.33 standard deviations (2.33σ) from the mean – that is, 2.33σ – and 2 percent of the
area under the normal distribution is found beyond ± 2.33 (1 percent under each tail, -2.33σ and
+2.33σ, respectively). Thus, for a one-tailed distribution, the 99 percent confidence level will
represent adverse moves that not occur more than 1 day in 100. In this example, it means 2.33 x
15 bp = 34.95 bp. Thus, the maximum adverse yield change expected for this zero-coupon bond
is an increase of 34.95 basis points, or 0.3495 percent, in interest rates.

b. If yield changes are normally distributed, 90 percent of the area of a normal distribution
will be 1.65 standard deviations (1.65σ) from the mean – that is, 1.65σ – and 10 percent of the
area under the normal distribution is found beyond ± 1.65 (5 percent under each tail, -1.65σ and
+1.65σ, respectively). Thus, for a one-tailed distribution, the 95 percent confidence level will
represent adverse moves that not occur more than 1 day in 20. Thus, the maximum adverse yield
change expected for this zero-coupon bond is an increase of (1.65 x 15 =) 24.75 basis points, or
0.2475 percent, in interest rates.

10. Price volatility = (MD) x (potential adverse move in yield)


= (12.5) x (0.0035) = 0.04375 or 4.375 percent

DEAR = ($ market value of position) x (Price volatility) DEAR = $2,150,000 = ($ value of


position) x 0.04375
= > ($ value of position) = $2,150,000/0.04375 = $49,142,857 = market value
Dollar value of position = $127,503,041/(1 + yield)13.42 = $49,142,857.
= > yield = ($127,503,041/$49,142,857)1/13.42 – 1 = 7.36%
Therefore, the bonds currently are yielding 7.36 percent in the over-the-counter market.

MD = D/(1 + R) = 12.5 = D/(1.0736) = > D = 12.5 x 1.0736 = 13.42 years

12. The first step is to calculate the dollar-equivalent amount of the position.
Dollar equivalent value of position = FX position x ($ per unit of foreign currency)
= €1.6 million x $1.25/€
= $2 million

If changes in exchange rates are historically normally distributed, the exchange rate must change
in the adverse direction by 2.33σ, or
FX volatility = 2.33 x 62.5 bp = 145.625 bp or 1.45625%
As a result,
DEAR = Dollar value of position x FX volatility
= $2 million x 0.0145625
= $29,125

This is the potential daily earnings at risk exposure to adverse euro to dollar exchange rate
changes for the bank from the €1.6 million spot currency holding.

15. Since the portfolio of stocks reflect the U.S. stock market index, the β = 1. Thus, the DEAR
for equities is:

DEAR = Dollar market value of position x Stock market return volatility


= $15,000,000 x 2.33 σm

The σm of the daily returns on the stock market index was 156 bp over the last year. So,

Stock market return volatility = 2.33 x 1.56% = 3.6348%


and
DEAR = $15,000,000 x 0.036348 = $545,220

That is, the FI stands to lose at least $545,220 in value if adverse stock market returns
materialize tomorrow.

16. DEAR = ($ market value of portfolio) x (2.33 x m ) = $10m x (2.33 x 0.015)


= $10m x 0.03495 = $349,500

5-day VAR = $349,500 x 5 = $349,500 x 2.2361 = $781,506


17.
0.5
(DEAR L ) 2 + (DEAR FX ) 2 + (DEAR EQ ) 2 
 
 + (2ρL , FX x DEAR L x DEAR FX ) 
DEAR portfolio =  
+ (2ρL , EQ x DEAR L x DEAR EQ )
 
 + (2ρFX , EQ x DEAR FX x DEAR EQ ) 

0.5
$300,7002 + $274,0002 + $126,7002 + 2(0.3)($300,700)($274,000) 
= 
+ 2(0.7)($300,700)($126,700) + 2(0.0)($274,000)($126,700) 

= [$284,322,626,000] = $533,219
0.5

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