Banking Risk Management – Homework 2

Student 1:
Full name: Nguyễn Phan Thanh Trúc
Student ID: BAFNIU18188

Student 2:
Full name: Nguyễn Thanh Nga
Student ID: BAFNIU18195

Question 1.3

ω1 ω2 μP σ ρ ( ρ=0.3) σ ρ ( ρ=1) σ ρ ( ρ=−1)

0.0 1.0 15% 24.00% 24.00% 24.00%
0.2 0.8 14% 20.39% 22.40% 16.00%
0.4 0.6 13% 17.42% 20.80% 8.00%
0.6 0.4 12% 15.48% 19.20% 0.00%
0.8 0.2 11% 14.96% 17.60% 8.00%
1.0 0.0 10% 16.00% 16.00% 16.00%

Question 1.4
Diversification is possible for nonsystematic risk, but not for systematic risk. To an equity
investor, systematic risk is more significant. Either kind of risk may result in a corporation's
insolvency.

Question 1.6
Use CAPM equation to compute the expected return
ER=R f + β ×(R m−R f )
a. β=0.2
We have: ER=0.06+0.2 × ( 0.12−0.06 )=7.2 %

b. β=0.5
We have: ER=0.06+0.5 × ( 0.12−0.06 )=9 %

c. β=1.4
We have: ER=0.06+1.4 × ( 0.12−0.06 ) =14.4 %

Question 1.9
Risk decomposition is a process in which risks are dealt with one by one. Risk aggregation is a
process that considers a portfolio of risks. 
Risk decomposition requires a thorough knowledge of individual risks. Risk aggregation requires
a knowledge of risk correlations.

Question 1.14
At zero alpha:
Return earned =Rf + β × ( R m−R f ) =0.05+0.6 × ( 0.10−0.05 ) =0.08=8 %
At alpha = 4%:
The hedge fund manager’s return = 8% + 4% = 12%
 We have: Rate of return=R f + β × ( Rm−R f ) + α

Question 2.6
Credit risk has a significant impact on loan losses. Non-interest income includes both profits and
losses from trading. As a result, market risk has an effect on non-interest income. If assets and
liabilities are not matched, it also has an effect on net interest income. Operational risk primarily
affects non-interest expense.

Question 2.8
H, C, F, A, B, D, E, and G are the bidders in order of highest price bid to lowest price bid. We
have:

Bidder Price Number of shares Cumulative demand

H $125.00 80000 80000
C $110.00 50000 130000
F $105.00 10000 140000
A $100.00 20000 160000 Reach a target
B $93.00 30000 190000

Therefore:

Bidder Shares offered

H 80000
C 50000
F 10000
A 10000 Only 10000 out of 20000
 H, C, and F all get their orders at that price. At A's price, half of A's order is fulfilled.

The other answer is dutch auction, also known as uniform auction, each bidder pays the same
price of $100 when they reach their desired number of shares to be auctioned.

Question 2.12
The trading book is a collection of instruments that a bank acquires via its trading operations.
The banking book contains instruments that the bank does not anticipate trading, such as loans to
businesses and individuals.

Question 2.15
The question specified the probability of DLC Bank not being wiped out by losses. With a mean
of $0.6 million and a standard deviation of $2.0 million. There is a 99.9% probability that the
profit will not be worse than:
= $ 0.6−3.090× 2.0 (With -3.090 is the value of standard deviation 99.9%)
=$ 0.6−6.18=−$ 5.58 million
Regulators will require $0.58 million ($ 5.58−$ 5.0 ¿ of additional capital.