Answer the following question given below:

1. What is meant by market risk?

2. Why is the measurement of market risk important to the manager of a financial institution?

3. What is meant by daily earnings at risk (DEAR)? What are the three measurable components? What is the price volatility component?

4. Follow Bank has a $1 million position in a five-year, zero-coupon 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?

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?

c. What is the price volatility of this bond?

5. What is meant by value at risk (VAR)? How is VAR related to DEAR in J.P. Morgan's RiskMetrics model? What would be the VAR for the bond in problem (4) for a 10-day period? What statistical assumption is needed for this calculation? Could this treatment be critical?

6. The DEAR for a bank is $8,500. What is the VAR for a 10-day period? A 20-day period? Why is the VAR for a 20-day period not twice as much as that for a 10-day period?

7. Bank Beta has an inventory of AAA-rated, 10-year zero-coupon bonds with a face value of $100 million. The modified duration of these bonds is 12.5 years, the DEAR is $2,150,000, and the potential adverse move in yields is 35 basis points. What is the market value of the bonds, the yield on the bond, and the duration of the bond?

8. Bank Two has a portfolio of bonds with a market value of $200 million. The bonds have an estimated price volatility of 0.95 percent. What are the DEAR and the 10-day VAR for these bonds?

9. Jeff Resnick, vice president of operations at Choice Bank, is estimating the aggregate DEAR of the bank's portfolio of assets consisting of loans (L), foreign currencies (FX), and common stock (EQ). The individual DEARs are $300,700, $274,000, and $126,700 respectively. If the correlation coefficients (?ij) between L and FX, L and EQ, and FX and EQ are 0.3, 0.7, and 0.0, respectively, what is the DEAR of the aggregate portfolio?

10. Calculate the DEAR for the following portfolio with the correlation coefficients and then with perfect positive correlation between various asset groups What is the amount of risk reduction resulting from the lack of perfect positive correlation between the various assets groups?

11. What are the advantages of using the back simulation approach to estimate market risk? Explain how this approach would be implemented.

12. Export Bank has a trading position in Japanese yen and Swiss francs. At the close of business on February 4, the bank had ¥300 million and Sf10 million. The exchange rates for the most recent six days are given below:

a. What is the foreign exchange (FX) position in dollar equivalents using the FX rates on February 4?

b. What is the definition of delta as it relates to the FX position?

c. What is the sensitivity of each FX position; that is, what is the value of delta for each currency on February 4?

d. What is the daily percentage change in exchange rates for each currency over the five-day period?

e. What is the total risk faced by the bank on each day? What is the worst-case day? What is the best-case day?

g. Explain how the 5 percent value at risk (VAR) position would be interpreted for business on February 5..

h. How would the simulation change at the end of the day on February 5? What variables and/or processes in the analysis may change? What variables and/or processes will not

13. Export Bank has a trading position in euros and Australian dollars. At the close of business on October 20, the bank had €20 million and A$30 million. The exchange rates for the most recent six days are given below:

a. What is the foreign exchange (FX) position in dollar equivalents using the FX rates on October 20?

b. What is the sensitivity of each FX position; that is, what is the value of delta for each currency on October 20?

c. What is the daily percentage change in exchange rates for each currency over the five-day period?

d. What is the total risk faced by the bank on each day? What is the worst-case day? What is the best-case day?

14. What is the primary disadvantage to the back simulation approach in measuring market risk? What effect does the inclusion of more observation days have as a remedy for this disadvantage? What other remedies can be used to deal with the disadvantage?

15. How is Monte Carlo simulation useful in addressing the disadvantages of back simulation? What is the primary statistical assumption underlying its use?

Academic requirements:

• Your work must be submitted as  pages 6-8 of pages

• Your work should be submitted in the formats outlined for each questionin the assignment.