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Book/movie review
22/08/2022
Question:
Question 1
a) Explain and compare three alternative methodologies for calculating Value at Risk (VaR) using market prices and explain which VaR methodology is most commonly used by:
Companies
Banks
b) Calculate the 1-day 95% VaR for each of the following individual positions and explain your results. You are not required to calculate the portfolio VaR.
i) $5 million (nominal) annual bond with modified duration of 2.34 and trading at a price of $97.5 per $100 par; the 1-day volatility of market interest rates is 20 basis points.
ii) $4 million (equivalent) of exposure to the euro and the standard deviation of the dollar against euro is 70 basis points.
iii) $3 million (market value) stock position with a beta of 1.20 and standard deviation of market index of 265 basis points.
Question 1
c) Calculate DV01 for a 1 million (nominal) 5% annual bond with three years remaining life that is currently trading at a yield of 3%.
d) Explain what DV01 means and how it can be used to hedge interest rate risk on a bond portfolio using interest rate swaps.
Question 2
Banks have been faced with additional demand for loans from corporates, bond rating downgrades and corporate credit defaults during the Covid-19 pandemic. Interest rates have remained low and, in many cases, fallen.
a) Discuss the additional financial risks faced by banks in 2020-21 as a result of the Covid19 pandemic crisis.
b) Explain the changes made to Basel regulatory requirements relating to liquidity (NSFR and LCR) following the global financial crisis of 2007-8.
c) Discuss the extent to which NSFR and LCR and other regulatory changes have protected the financial system during the Covid-19 pandemic crisis or 2020-21.
Question 2
Information for use in Question 2 parts d) and e)
Bank P has the following assets and liabilities:
Cash
4
Retail deposits (stable)
20
Treasury Bonds (> 1 year)
6
Retail deposits (less stable)
20
Corporate Bonds with A+ rating
10
Wholesale deposits
45
Equity securities
10
Borrowings
5
Loans to small business customers
40
Tier 2 capital
5
Non-current assets
30
Tier 1 capital
5
TOTAL
100
TOTAL
100
The bank has a target NSFR of at least 100%.
Calculate Bank Ps Net Stable Funding Ratio (NSFR) and state whether it meets the target.
Calculate the value of new less stable deposits required by Bank P in order to achieve a NSFR of 100%, assuming Bank P invests the new funds in equity securities.
Question 3
a) Options on the NYSE stock index:
Option
Strike price ($)
Premium ($)
Call
45
4
Call
55
2
Construct a bull spread using the options given above. Prepare a table showing the payoff and profit/loss for each option and for the bull spread.
b) The graph given below is the profit/loss graph for the bull constructed in part a) above. State missing values A, B, C and D and the significance of each value. Note: the graph is not drawn to scale.
Question 3 continued
Compare and contrast the characteristics and use of a one-day bull spread to:
One-day long call
One-day short put
Explain what short selling means and how short-sellers profit from a fall in share prices.
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