General Guidelines for Submission of Coursework

Relative Degree of Risk and Risk Reduction Strategies

General Guidelines for Submission of Coursework

1. Save your final file as a pdf file using your SID number as the file name for Turnitin submission.
2. The word count excludes tables, charts, graphs, formulas, appendices and reference list, that is, the word count refers only to the narrative. Your target word count is 1,500.
3. The reference list must consist of reputable and/or peer-reviewed sources. The formatting should follow the Harvard Referencing guidelines (Version 6.1.2 April 2019).
4. You can include charts and tables from Excel to show the results of calculations etc.
5. Colour output is allowed, but black and white format is sufficient.
6. Turn on the spelling checker in your word processor. Use either British English or American English, but be consistent throughout.
7. Check Turnitin access at least one week prior to submission.

Claims for mitigation are submitted by the student, or in exceptional circumstances (e.g. when a student has been hospitalised) by a Director of Studies or Student Adviser on behalf of the student, no later than five working days after the published (or extended) submission deadline of the assessed work.

In the parts of the assessment which involve calculations with market data, you must provide detailed explanations of your reasoning and workings to get a good score. It is not sufficient just to present the results of calculations without full explanation. It will be best to perform you calculations in Excel and copy and paste sections of your spreadsheets to help show how you are using the data and making calculations.

Give a general explanation of and comparison between volatility, Value at Risk (VaR) and Expected Shortfall (ES) as risk measures for market risk. Explain the difference between parametric and nonparametric VaR/ES. 12 marks For the following questions (2, 3 and 4) you will need to use historical market data. A comma-separated variable file historical data.csv is provided on Canvas containing market data for the period from the beginning of September 2018 until the end of September 2020. Three time series are included: the price (adjusted for dividends) of HSBC shares in pounds on the London Stock Exchange; a composite series of the price of the nearest futures contract on the FTSE 100 index in pounds; and the yield to maturity for 10-year UK government bonds.

Using suitable volatility measures for the stock, bond and futures contract and suitable correlations, describe the relative degree of risk of the three securities and any relationships between them that might be useful for reducing risk in a portfolio constructed from them. 10 marks

On 29th September 2020 an investor is planning to invest £1 million in a portfolio containing HSBC shares and a newly issued 10-year

Government bond paying an annual coupon of rate 0.3%. 60% of the funds will be invested in the share and the remainder in the bond. The investor wants to know about the risks involved in holding this portfolio and will use the daily changes in prices and yields in the historical data to provide possible scenarios for a one-day change in the value of the portfolio. The investor has an investment horizon of one month (assume 20 business days).

(a) Describe the portfolio composition and the expected distribution of its one-day performance given the historical scenarios, using basic statistical measures and charts.

(b) On the assumption that the portfolio loss is normally distributed, what would you report to the investor for the VaR of the portfolio over the horizon period with confidence levels of 90%, 95% and 99%? How would you explain these numbers to him?

(c) If you made no assumption about the shape of the loss distribution, what VaR numbers would you report and how would you explain the differences between the two sets? 4 marks

(d) Also report the horizon period ES for the portfolio with a 99% confidence level and explain what this means to the investor.

(e) What advice would you give to the investor about the use of these risk measures?

Now the investor wants to know if the risk can be reduced by adding a short FTSE 100 futures position to the portfolio, with a nominal value equal to 50% of the value of the HSBC shares. (You can assume that futures contracts can be shorted in fractional amounts and you can ignore any margin payments necessary to enter or maintain the futures position.) Adjust the results that you reported previously and explain them. What would be your advice about this hedging strategy?