Part A Market Risk 1200 words 40 marks

critically discuss market risk and the measurement using VaR technique

Explain how VaR technique is applied for banking risk management . Clearly explain and
interpret your portfolio results capturing your data and the latest published research
° use references
Select a portfolio of 5 companies (should consist of at least five real-world assets), with
equal weightage in portfolio (20% each) and the length of your sample period should be
more than 1 year and no longer than five years and must end before 31st December
2022.
° Justify your selection in 1-2 sentences

showcase your understanding of the VaR technique through analysis these 5 companies
1° VAR- using Variance-Covariance Method (VCV VaR)
µ = Average Portfolio Return
1. ln(pt/pt-1) for each stocks daily return
2.sum all log returns for the daily portfolio (add all stocks returns horizontally for
everyday)
3. average daily portfolio returns
4. STDEV.S(daily return of each stock)
5.weight (20%) x SD of each stock- WNƠN
6. Variance of daily returns = MMULT(MMULT(TRANSPOSE(WNON), CorrMax),
WNON)
7.SD of daily returns= SQRT(Variance)
application
Confidence level 95% 97.5% 99%
Significance level (α) 5% 2.5% 1%
Value of investment portf Inv portf Inv portf Inv
Z alpha -1.645 -1.960 -2.326
Portfolio Return step 2 step 2 step 2
SD of daily returns step 7 step 7 step 7
VaR using VCV (1-day) (-(Return+(Zalpha x SD))*value of Investment
VaR using VCV (1-year) VaR using VCV (1-day) X SQRT(N)
Advantages, Critiques, Limitations of the VAC method
2° VAR- using Historical Simulation Method
1. ln(pt/pt-1) for each stocks daily return
2.sum all log returns for the daily portfolio (add all stocks returns horizontally for
everyday)
3. calculate min and max of portfolio returns-
4. matrix -asset & portfolio, value, weight
5. matrix - ascending returns- (bin(=min, min+0.25%), frequency)- use histogram input
=portfolio returns, bin=calculated bin, chart output, change histogram chart to line chart
6. analyze Maximum potential loss and minimum potential loss/ profit ( Max X Port Inv;
Min X Port Inv)
7. point out the HS Var at different Confidence Intervals in the graph

application
Confidence level 95% 97.5% 99%
Significance level (α) 5% 2.5% 1%
Value of investment portf Inv portf Inv portf Inv
HS VaR in % PERCENTILE.EXC(portfolio return array,signif lev)
HS VaR (1-day) ABS(Port Inv X HS VaR in %)
HS VaR (1-year) HS VaR (1-day) * SQRT(N)
Advantages, Critiques, Limitations of the HS method
3° VAR- CVaR
Count N = No: of days
No: of days applicable for given
confidence interval count N x significance level
average up to HS Var in % inclusive in the
portfolio return after rearranging the
CVaR in % (Expected Shortfall portfolio return of all count days in
%) ascending days
CVaR (1-day) (Expected
Shortfall) Port Inv X CVAR%
CVaR (1-year)(Expected
shortfall-annual) CVaR (1-day) X SQRT(N)
Advantages, Critiques, Limitations of the HS method
4° VAR- using Monte Carlo Simulation
portfolio matrix
Value of Investment Portfolio Value
AVERAGE DAILY PORTFOLIO
RETURN AVERAGE(PORTFOLIO RETURNS ARRAY)
AVERAGE DAILY SD OF PORTFOLIO
RETURN STDEV.S (PORTFOLIO RETURNS ARRAY)
ANNUALISED Mean RETURN (1+AVERAGE DAILY
AVERAGE DAILY SDPORTFOLIO RETURN)^252-1
OF PORTFOLIO RETURN
ANNUALISED SD *SQRT(252)

EXPECTED RETURN ANNUALISED RETURN -1/2*(ANNUALISED SD ^2)

TIME INCREMENT = 1/N
simulation matrix
Simulations Rand () NORMSINV Return
1-1000 NORMSINV(Rand) EXPECTED RETURN*TIME
INCREMENT+ANNUALISED
SD*GENERATED
FIGURE*SQRT(TIME
INCREMENT
Value at Risk (VaR) using Monte Carlo Simulation
Confidence level 95% 97.5% 99%
Significance level (α) 5% 2.5% 1%
Portfolio value portf Inv portf Inv portf Inv
MCS GIVEN VaR IN % PERCENTILE.EXC (SIMULATION ARRAY,PROBABILITY)
MCS VaR (1-day) ABS(VaR IN % * PRINCIPAL INVESTMENT)
MCS VaR (1-year) MCS VaR (1-day) * SQRT(N)
Advantages, Critiques, Limitations of the HS method
VaR (VCA, HS,CVaR,MCS) Methods theoretical/ application comparison
VaR (VCA, HS,CVaR,MCS) Results comparison
New Developments in VaR-showcase knowledge of new developments in market risk
management
Part B(i) Credit Risk 1200 words 40 marks
Credit Risk and credit metrics-showcase detailed research and understanding of
the CreditMetrics
analyze a portfolio of loans(senior unsecured debt denominated in US dollars) as of
Oct 30 2022, consisting of 2 companies of your choice with characteristics shown in
the table below.- The loan will be repaid at the maturity date.
Derive
1. loan value distribution using CreditMetrics (full implementation)
2. compute relative VaR and
3. Expected Shortfall with Monte-Carlo simulation
for the loan portfolio at time horizons of 1-year and 2-year periods and the confidence
interval of 99%.
Interpret the credit metrics output from
a) risk management
b) regulatory point of view

support your claims with relevant literature.

Part B(ii) Credit Risk 600 words 20 marks
showcase detailed research and understanding of KMV risk measurement approach
Gather balance sheet data and market cap of the same two companies of part B(i)
showcase evidence of calculations and understanding of results.
calculate DPT figures and equity returns.
Use solver to solve for BS-S=1 to get V(A) which can then be translated into
vol(ret(A)), repeat until these figures converge.
Calculate vol(ret(MC)), mu(ret(A)) and mu(ret(MC)).
calculation of PD, Z(PD), APD and EDF
Calculate the Expected Default Frequency (EDF) for both loans using KMV
Compute the future prices of loans and portfolio risk in the default and no-default
scenarios at time horizons of 1-year and 2-year periods.
Apply original question data, risk free spot rates (assumed from Bloomberg) and
risk-free forward rates to calculate state price in case of default and no-default.
Compare PDs and EDF of both companies for year 1 & 2
showcase evidence of calculations and understanding of results.
Interpret the KMV output- PD & EDF from
a) risk management
b) regulatory point of view
compare results with those obtained using CreditMetrics in part 1.
Explain any differences observed supporting your discussion with relevant literature.
Grade Total 80 weightage
Deadline 10 th January 202

Length maximum of 3000 words (with a tolerance level of 10%), which must be stated
at the cover page of the assignment.
Quotations of more than 2 lines must be indented and in italics with the reference and
page number stated. Shorter quotations should be in italics but do not need to be
indented.

Tables and diagrams should be inserted at an appropriate point in the text and should
be easily readable.
All the results, their interpretation and discussion should be provided in a single MS
Word document.
total maximum plagiarism -20% and not more than 5% from one source
APA referencing to be followed