Question 1:

In table 2.2, the total equity capital of DLC is $5m so the net loss after tax of DLC has to be equal or larger than -$5m for
the equity to be wiped out. In addition, because the tax is allowed to be carried back, the pre- tax loss must larger or
equal to -$5m/(1- 25%) = -$6.7m
Because DLCs income before tax normally distributed with a mean of 0.6 and standard deviation of 3.0, we use the
excel NORM.DIST(-6.7,0.6,3,TRUE) = 0.748%
Question 2:
Assumption Calculation

Annual wage 100 Final salary = 100 x (1+0.02)^44 = 239.01

Real rate 2% 1st payout = 70% x Final salary = 167.30

Contribution time (yrs) 45
Pension paytout 70%
Pension payout rate -1%
Pension time (yrs) 18
Bond rate 1.5%

The contribution rate will be the rate that make the total pension at year 18 become zero. To find the
contribution rate, set up the table to calculate the accumulated pension (annual contribution + investment
income). After that, using Goal Seek function in Excel to find the contribution rate so that the pension at year
18 becomes 0. The contribution rate found by the function was 25%.
Payout table

Yr Beginning amt Real growth Payout

1 167.30 1.00 167.30
2 167.30 0.99 165.63
3 165.63 0.99 163.97
4 163.97 0.99 162.33
5 162.33 0.99 160.71
6 160.71 0.99 159.10
7 159.10 0.99 157.51
8 157.51 0.99 155.94
9 155.94 0.99 154.38
10 154.38 0.99 152.83
11 152.83 0.99 151.31
12 151.31 0.99 149.79
13 149.79 0.99 148.30
14 148.30 0.99 146.81
15 146.81 0.99 145.34
16 145.34 0.99 143.89
17 143.89 0.99 142.45
18 142.45 0.99 141.03
Total 2,768.65
 Contribution table Investment income table

Yr Beginning wage Contribution rate Contribution amt Acc Pension Bond rate Invesment income
1 100.00 25% 25.40
2 102.00 25% 25.91 25.40 1.5% 0.38
3 104.04 25% 26.42 51.68 1.5% 0.78
4 106.12 25% 26.95 78.88 1.5% 1.18
5 108.24 25% 27.49 107.02 1.5% 1.61
6 110.41 25% 28.04 136.11 1.5% 2.04
7 112.62 25% 28.60 166.20 1.5% 2.49
8 114.87 25% 29.17 197.29 1.5% 2.96
9 117.17 25% 29.76 229.43 1.5% 3.44
10 119.51 25% 30.35 262.62 1.5% 3.94

42 225.22 25% 57.20 2,087.53 1.5% 31.31

43 229.72 25% 58.34 2,176.05 1.5% 32.64
44 234.32 25% 59.51 2,267.03 1.5% 34.01
45 239.01 25% 60.70 2,360.55 1.5% 35.41
1 2,289.36 1.5% 34.34
2 2,158.07 1.5% 32.37
3 2,026.46 1.5% 30.40
4 1,894.52 1.5% 28.42
5 1,762.23 1.5% 26.43
6 1,629.56 1.5% 24.44
7 1,496.49 1.5% 22.45
8 1,363.00 1.5% 20.45
9 1,229.07 1.5% 18.44
10 1,094.67 1.5% 16.42
11 959.78 1.5% 14.40
12 824.38 1.5% 12.37
13 688.45 1.5% 10.33
14 551.97 1.5% 8.28
15 414.90 1.5% 6.22
16 277.24 1.5% 4.16
17 138.94 1.5% 2.08
18 0.00 1.5% 0.00

Question 3
Hedge fund charge

Mgt fee 2% Net profit 20%

Earned
Earned
Portfolio Weight Charges after
b4 fee
fee
1. 0.17 -20.0% 2.0% -22.0%
2. 0.17 -9.0% 2.0% -11.0%
3. 0.17 15.0% 4.6% 10.4%
4. 0.17 25.0% 6.6% 18.4%
5. 0.17 25.0% 6.6% 18.4%
6. 0.17 30.0% 7.6% 22.4%
Avg earning 11.0% 4.9% 6.1%
Fund of fund charge
Net
Mgt fee 1% profit 5%
Earned
Earned
Portfolio Weight Charges after
b4 fee
fee
1. 0.17 -22.0% 1.0% -23.0%
2. 0.17 -11.0% 1.0% -12.0%
3. 0.17 10.4% 1.4% 9.0%
4. 0.17 18.4% 1.8% 16.6%
5. 0.17 18.4% 1.8% 16.6%
6. 0.17 22.4% 2.0% 20.4%
Avg earning 6.1% 1.5% 4.6%

Question 4
Original

Losses to Losses to Losses to Losses to Losses to

Mezzanine
Subprime Mezzanine Equity Tranche Tranche Senior Tranche
Portfolio Tranche of ABS of ABS CDO of ABS CDO of ABS CDO
10% 25% 100% 100% 0%
15% 50% 100% 100% 33%
20% 75% 100% 100% 67%
25% 100% 100% 100% 100%

Structure changed to ABS and ABS CDO (70%, 20%, 10%)

Losses to Losses to Losses to Losses to Losses to

Mezzanine
Subprime Mezzanine Equity Tranche Tranche Senior Tranche
Portfolio Tranche of ABS of ABS CDO of ABS CDO of ABS CDO
10% 0% 0% 0% 0%
15% 25% 100% 75% 0%
20% 50% 100% 100% 29%
25% 75% 100% 100% 64%
Question 5

Including CCP
Dealer A B C Total Dealer A B C CCP Total
A 0 0 0 A 0 0 120 120
B 50 50 100 B 100 20 0 120
C 20 0 20 C 90 0 0 90
Avg 40 Avg 110

Excluding CCP
Dealer A B C Total
A 0 0 0
B 100 20 120
C 90 0 90
Avg 70

140
140

Including CCP
Dealer A B C Total Dealer A B C CCP Total
A 0 120 120 A 0 50 120 170
B 50 50 100 B 100 20 0 120
C 0 0 0 C 0 0 0 0
Avg 73.333 Avg 96.667

Excluding CCP
Dealer A B C Total
A 0 50 50
B 100 20 120
C 0 0 0
Avg 56.667
Question 6
EWMA to the Data on Euro USD table
Date USD per E Return Variance Likelihood Volatility Autocorrelation Analysis

2005-07-27 1.199
2005-07-28 1.21 0.009174
2005-07-29 1.2093 -0.000579 0.00008417 9.3787 1 0.91743119 3.3468E-07 3.9763E-03
2005-08-01 1.2219 0.010419 0.00008068 8.0794 2 0.89821545 1.0856E-04 1.3456E+00
2005-08-02 1.2217 -0.000164 0.00008184 9.4104 3 0.90465162 2.6791E-08 3.2736E-04
2005-08-03 1.2308 0.007449 0.00007843 8.7459 4 0.88563339 5.5482E-05 7.0737E-01
2005-08-04 1.2319 0.000894 0.00007748 9.4552 5 0.88022403 7.9875E-07 1.0309E-02
2005-08-05 1.2386 0.005439 0.00007429 9.1094 6 0.86190607 2.9580E-05 3.9818E-01

2010-07-22 1.285 0.002575 0.00005879 9.6288 1274 0.76672334 6.6291E-06 1.1277E-01

2010-07-23 1.2897 0.003658 0.00005662 9.5429 1275 0.75243492 1.3378E-05 2.3629E-01
2010-07-26 1.2931 0.002636 0.00005482 9.6847 1276 0.74038095 6.9499E-06 1.2679E-01
2010-07-27 1.3033 0.007888 0.00005282 8.6707 1277 0.72680349 6.2221E-05 1.1779E+00 Ljung-Box Ljung-Box
Lag w_k Before EWMA After EWMA
11806.4767 1 0.345 0.030 1.0023511 1.1896E-01 8.9709E-04
lambda 0.958382905 2 0.149 -0.024 1.00313725 2.2417E-02 5.6607E-04
3 0.089 0.003 1.00392465 7.9021E-03 6.9305E-06
4 0.126 -0.023 1.00471328 1.5901E-02 5.3960E-04
5 0.164 0.001 1.00550314 2.6925E-02 1.4194E-06
6 0.204 0.024 1.00629426 4.1922E-02 5.8462E-04
7 0.110 0.004 1.00708661 1.2152E-02 1.3139E-05
Solver finds value of lambda (cell 8 0.119 0.000 1.00788022 1.4245E-02 9.7362E-08
C1284) that maximizes the 9 0.148 -0.010 1.00867508 2.2025E-02 1.1068E-04
likelihood function in cell E1283 10 0.139 -0.028 1.00947119 1.9434E-02 7.8581E-04
11 0.081 -0.039 1.01026856 6.6940E-03 1.5071E-03
12 0.047 0.015 1.01106719 2.2459E-03 2.1645E-04
13 0.142 0.042 1.01186709 2.0370E-02 1.7604E-03
14 0.144 -0.020 1.01266825 2.0889E-02 4.0177E-04
15 0.078 -0.012 1.01347068 6.1599E-03 1.4656E-04

4.5748E+02 9.6257E+00

GARCH (1,1) to the Data on Euro USD Table

Date USD per E Return Variance Likelihood Volatility Autocorrelation Analysis

2005-07-27 1.199
2005-07-28 1.21 0.009174
2005-07-29 1.2093 -0.000579 0.00008417 9.3787 1 0.91743119 3.3468E-07 3.9763E-03
2005-08-01 1.2219 0.010419 0.00007756 8.0648 2 0.88067362 1.0856E-04 1.3997E+00
2005-08-02 1.2217 -0.000164 0.00007888 9.4473 3 0.88813836 2.6791E-08 3.3965E-04
2005-08-03 1.2308 0.007449 0.00007272 8.7659 4 0.85277142 5.5482E-05 7.6294E-01
2005-08-04 1.2319 0.000894 0.00007088 9.5433 5 0.84187855 7.9875E-07 1.1270E-02
2005-08-05 1.2386 0.005439 0.00006549 9.1820 6 0.80924197 2.9580E-05 4.5169E-01

2010-07-22 1.285 0.002575 0.00005299 9.7202 1274 0.72797082 6.6291E-06 1.2509E-01

2010-07-23 1.2897 0.003658 0.00004960 9.6418 1275 0.70427748 1.3378E-05 2.6971E-01
2010-07-26 1.2931 0.002636 0.00004697 9.8181 1276 0.68533518 6.9499E-06 1.4797E-01
2010-07-27 1.3033 0.007888 0.00004414 8.6185 1277 0.66434804 6.2221E-05 1.4098E+00 Ljung-Box Ljung-Box
Lag w_k before GARCH after GARCH
0.0898 0.0000008984 11793.7120 1 0.345 0.028 1.0023511 1.1896E-01 8.1152E-04
0.91053 0.910530 2 0.149 -0.024 1.00313725 2.2417E-02 5.7417E-04
0.6781 0.067806 3 0.089 0.002 1.00392465 7.9021E-03 4.1981E-06
4 0.126 -0.030 1.00471328 1.5901E-02 8.9805E-04
Long run variance per day 0.000041471 5 0.164 0.015 1.00550314 2.6925E-02 2.1785E-04
Long run volatility per day 0.006440 6 0.204 0.020 1.00629426 4.1922E-02 3.8306E-04
Long run volatility per year 0.10222893 7 0.110 0.010 1.00708661 1.2152E-02 1.0167E-04
8 0.119 -0.008 1.00788022 1.4245E-02 6.4623E-05
Solver searches over 9 0.148 -0.012 1.00867508 2.2025E-02 1.4961E-04
B1283 (which is *100000) 10 0.139 -0.024 1.00947119 1.9434E-02 5.8876E-04
B1284 (which is ) 11 0.081 -0.029 1.01026856 6.6940E-03 8.7582E-04
B1285: (which is *10) 12 0.047 0.005 1.01106719 2.2459E-03 2.9288E-05
The likelhood function (to be 13 0.142 0.044 1.01186709 2.0370E-02 1.9202E-03
maximized) is in E1283 14 0.144 -0.007 1.01266825 2.0889E-02 5.3599E-05
, , and are in 15 0.078 -0.021 1.01347068 6.1599E-03 4.3816E-04
C1283:C1285.
4.5748E+02 9.0802E+00
Question 7

Prob(v>x) = Kx^(-a)

Given
x= $10
Prob (v>x) = 4%
Kx^(-a) = Kx10^(-a) = 0.04
K= 0.04/(10^(-a) )

When a = 3
K= 40
Prob(v>x) = 40x^(-3)

Given VaR at 99%

Prob(v>x) = 40x^(-3) = 0.01
0.01/40
x^(-3) = = 1/4000
x= 16

The Power Law gives "we are 99% certain that we will not lose more than $16m in 1 day"

Question 8

For V1 1 = 1.0
Prob density function for exp dist. = e^(-x)
Cumulative prob. Dist. = 1 e^(x)
For V2 2 = 2.0
Prob density function for exp dist. = 2e^(-2x)
Cumulative prob. Dist. = 1 e^(2x)
Copula Correl. -0.2

Calculate U1 and U2 using NORMSINV function

V1 Pdf (V1) U1 V2 Pdf (V2) U2
- -
0.25 0.22 0.768 0.25 0.39 0.270
-
0.50 0.39 0.270 0.50 0.63 0.337

0.75 0.53 0.069 0.75 0.78 0.762

1.00 0.63 0.337 1.00 0.86 1.102

1.25 0.71 0.564 1.25 0.92 1.391

1.50 0.78 0.762 1.50 0.95 1.647

Cumulative Joint Probability for V1 and V2 in the Gausian Copula

Model
 (using the cumulative bivariate norm. dist. Macro table)

V2

V1 0.25 0.50 0.75 1.00 1.25 1.50

0.25 0.065 0.117 0.153 0.177 0.193 0.203

0.50 0.125 0.219 0.282 0.323 0.349 0.366

0.75 0.177 0.303 0.386 0.439 0.472 0.493

1.00 0.219 0.371 0.469 0.531 0.569 0.593

1.25 0.254 0.426 0.535 0.603 0.645 0.672

1.50 0.282 0.469 0.587 0.660 0.705 0.733

Question 9

WCDR (T, X) = N (N^-1(PD) + sqrt(p)N^-1(X) / (sqrt(1-p)))

WCDR (1, 0.995)

default rate 1.50% Since portfolio size is $50 million, and recovery rate is 60%
T 1 VaR is the WCDR of 40% of $50million
X 99.50% WCDR VaR

p1 0 1.5% 300,000.00

p2 0.1 7.7% 1,530,426.54

p3 0.2 12.7% 2,549,868.23

p4 0.3 18.2% 3,641,540.81

p5 0.4 24.2% 4,849,153.15

p6 0.5 31.1% 6,219,122.99

p7 0.6 39.1% 7,821,790.87

p8 0.7 48.9% 9,781,561.83

p9 0.8 61.8% 12,352,041.62

p10 0.9 80.6% 16,129,939.17

recovery rate 60%

Question 10

Profit/(loss) Prob. Note

-$10m 4% a
-$1m 2% b
+$1m 94% c

a) VaR of each investment when confidence lv is 95%

Since the investment has a94% Prob. of a +$1m profit and 2% Prob. Of a -$1m loss. The 95% VaR is $1m
b) What is the expected shortfall when the confidence level is 95%?
Of the 5% tail of the loss distribution, 1% corresponds to a -$1m loss and 4% corresponds to a -$10m loss. There is a 1/5
prob. Of a loss of -$1m and a 4/5 prob. Of a loss of -$10m.
ES = 1/5 x 1 + 4/5 x 10 = $8.2m
c) What is the VaR for a portfolio consisting of the two investments when the confidence level is 95%?

Note Prob. Loss Note Prob. Loss

aa 0.16% -20 cc 88.36% 2
bb 0.04% -2 bc 3.76% 0
cc 88.36% 2 bb 0.04% -2
ab 0.16% -11 ac 7.52% -9
ac 7.52% -9
bc 3.76% 0
Total 100.00% 99.68%
For 95% confidence lv, the VaR will be $9m
d) What is the expected shortfall for a portfolio consisting of the two investments when the confidence level is 95%?
Of the 5% tail of the loss distribution

Note Prob. Loss Proportion

aa 0.16% -20 3.20%
ab 0.16% -11 3.20%
ac 7.52% -9 93.60%
ES = 3.2% x 20 + 3.2% x 11 + 93.6% x 9 = 9.4m
e) Show that, in this example, VaR does not satisfy the subadditivity condition whereas expected shortfall does.

VAR Consider separately -$1m + -$1m = -$2m

Put together -$9m

ES Consider separately -$8.2m + -$8.2m = -$16.4m

Put together -$9.4m

Since ES when put together is smaller than the sum of 2 ES and VaR when put together is larger than sum of 2 VaR, the
subadditivity condition is satisfied as the combined portfolio should reduce risk by diversification.