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RSK4805
Assignment 3
2024 - DUE 15
August 2024
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Market Risk Management
RSK4805 Assignment 3 (COMPLETE ANSWERS) 2024 - DUE 15 August
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Question 1 (25 marks) 1.1 A bank estimates that its profit next year is
normally distributed with a mean of 0.8% of assets and a standard deviation of
2% of assets. How much equity (as a percentage of assets) does the
company need to be 99% sure that it will have positive equity at the end of the
year? (Use z-values rounded to two decimal places) (2) 1.2 Given the
following information for a listed company, the expected return if invested in
the shares of this company is 7.80%. Calculate the variance and the standard
deviation of this expected return. (3) State of Economy Probability Percentage
Return State 1 0.30 13% State 2 0.35 8% State 3 0.15 2% State 4 0.20 4%
1.3 Describe an exchange-traded fund (ETF) and identify an advantage of an
ETF compared to a closed-end fund (CEF). (2) 1.4 Suppose you currently
hold a security valued at R750, and the prevailing risk-free rate is 5.5%. You
plan to sell this security in three months. The theoretical forward contract price
is calculated at R760.12 and will be used to hedge against potential price
declines. Now, if the dealer offers a tradable price to unlock the arbitrage profit
of R745 on the forward contract, determine the arbitrage opportunity available
to you, and subsequently, provide a calculation for the potential arbitrage
profit. (5) 1.5 You are a risk manager at a big corporation. How can you
update the volatility estimate for an asset when the closing price yesterday
was R375, and the estimated daily volatility was 1.2%? Today’s closing price
is R371. You need to consider the following two methods for updating the
volatility estimate: a) EWMA model with λ = 0.95 b) GARCH (1,1) model with
ω = 0.000003, α= 0.05, and β = 0.95 (Round all calculations to eight decimal
places) (5) Page 3 1.6 An analyst provided data for two assets, Asset A and
Asset B, including their current daily volatilities, prior and current daily closing
prices, coefficient of correlation between the returns of these two assets, the
covariance, and the parameter λ used in the EWMA model. With today's
