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End of Chapter 10 Questions
1.
What is meant by
market risk
?
Market risk is the uncertainty of the effects of changes in economywide systematic
factors that affect earnings and stock prices of different firms in a similar manner.
Some
of these marketwide risk factors include volatility, liquidity, interestrate and inflationary
expectation changes.
2.
Why is the measurement of market risk important to the manager of a financial
institution?
Measurement of market risk can help an FI manager in the following ways:
a.
Provide information on the risk positions taken by individual traders.
b.
Establish limit positions on each trader based on the market risk of their
portfolios.
c.
Help allocate resources to departments with lower market risks and appropriate
returns.
d.
Evaluate performance based on risks undertaken by traders in determining
optimal bonuses.
e.
Help develop more efficient internal models so as to avoid using standardized
regulatory models.
3.
What is meant by
daily earnings at risk (DEAR)
?
What are the three measurable
components?
What is the price volatility component?
DEAR or Daily Earnings at Risk is defined as the estimated potential loss of a portfolio's
value over a oneday unwind period as a result of adverse moves in market conditions,
such as changes in interest rates, foreign exchange rates, and market volatility. DEAR is
comprised of (a) the dollar value of the position, (b) the price sensitivity of the assets to
changes in the risk factor, and (c) the adverse move in the yield.
The product of the price
sensitivity of the asset and the adverse move in the yield provides the price volatility
component.
4.
Follow bank has a $1 million position in a fiveyear, zerocoupon bond with a face
value of $1,402,552.
The bond is trading at a yield to maturity of 7.00 percent.
The
historical mean change in daily yields is 0.0 percent, and the standard deviation is
12 basis points.
a.
What is the modified duration of the bond?
MD = 5 ÷ (1.07) = 4.6729 years
b.
What is the maximum adverse daily yield move given that we desire no more
than a 5 percent chance that yield changes will be greater than this maximum?
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Potential adverse move in yield at 5 percent = 1.65
σ
= 1.65 x 0.0012 = .001980
c.
What is the price volatility of this bond?
Price volatility
= MD x potential adverse move in yield
= 4.6729 x .00198 = 0.009252 or 0.9252 percent
d.
What is the daily earnings at risk for this bond?
DEAR
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.
 Spring '09
 tsui

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