Chapter Ten
Market Risk
Chapter Outline
Introduction
Market Risk Measurement
Calculating Market Risk Exposure
The RiskMetrics Model
The Market Risk of FixedIncome Securities
Foreign Exchange
Equities
Portfolio Aggregation
Historic or Back Simulation
The Historic (Back Simulation) Model versus
RiskMetrics
The Monte Carlo Simulation Approach
Regulatory Models: The BIS Standardized Framework
Fixed Income
Foreign Exchange
Equities
The BIS Regulations and Large Bank Internal Models
Summary
115
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View Full DocumentSolutions for EndofChapter Questions and Problems: Chapter Ten
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 market
wide 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?
Potential adverse move in yield at 5 percent = 1.65
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 Spring '10
 raymond
 Financial Markets, Risk in finance, Tier 1 capital

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