FINAL ASSESSMENT COVER SHEET
Course Code: BAFI1029
Course Description: Risk Management
Exam Date 29/04/2020
Release time: 10:00 am SGP Time
Submission cut off time: 12:30 am SGP time
Exam Duration: 2 hours + 15 min reading time + 15 additional minutes for download and submission
Total number of pages: 14 pages
INSTRUCTIONS TO CANDIDATES
1 The assessment consists of a series of 5 problems with scenario analysis. You must complete all problems and each component of the problem. The assessment is worth a total of 50 marks.
2 This is an OPEN BOOK assessment.
3 You are expected to answer the questions within the scope of this course covering Topic 1 to 8.
4 Please write your answers in the space provided on this assessment paper after each question.
5 This exam paper adds to 50 marks and comprises 50% of the total marks allocated in this course. To obtain a pass in this course, you must achieve at least 50 % overall in course assessment
1 This assessment must be submitted electronically via Canvas in .doc .docx. or pdf format only and must constitute your own work. Submission for this assignment is via Turnitin, therefore it is automatically checked for any form of plagiarism, resulting in academic misconduct if plagiarism occurs. You are required to upload the file in ..doc .docx. or pdf format only. If the file is uploaded in any other format that is not recognised via Turnitin and you don’t receive a similarity score – the assessment will not be marked and a grade of zero for the assessment will be applied.
2 You can only submit once as your final answer.
3 Name your answer file as: surname_studentID before submission.
4 As this is a final assessment, late submissions will not be accepted. If circumstances occur that prevent you being able to undertake the assessment on the due date – you will have to apply for special consideration: This webpage provides instructions about how to go about this: https://www.rmit.edu.au/students/student-essentials/assessment-and-exams/assessment/special-consideration
5 The submission window will close exactly at the cut-off time. Please submit well before cut-off time to ensure that nothing impedes your ability to upload the assessment, such as internet/wifi issues. This will not be a sufficient excuse to grant extensions – you are responsible for ensuring that you are able to submit the assessment on time.
1 Where mathematical calculations are required you must state the equation used as well as each step in your calculations. The detail workings can be a screenshot or photo insert in the document.
2 Please write answers in the spaces provided. You can extend the space to fit your answers, but please label the sub-question number clearly.
The format is detailed below:
Font type: Arial
Font size: 12pt
This is an individual piece of assessment. That means it must be your own work and you can’t copy or have someone else complete any part of the work for you.
By submitting this assessment, you are declaring that you have read, understood and agree to the content and expectations of the Assessment declaration.
Final Assessment Questions
“As of February 2020, the number of people infected with the coronavirus Covid-19 has surpassed 80,000, with nearly 2,700 deaths. Efforts to contain the outbreak have led to full or partial quarantines of several Chinese provinces and cities, as well as other countries that have been hit. The movement restrictions that have been implemented currently affect 500 million people.”
As the human costs in China and other countries continue to rise, the virus is also taking its toll on different industrial sectors – and subdued demand and disrupted supply across industries increase uncertainty over the global economy. The ongoing spread of the new coronavirus has become one of the biggest threats to the global economy and financial markets”.
Based on the information provided along with the question and knowledge in this course, please answer the following 5 questions. Each question is 10 marks. Total is 50 marks.
• The Federal Reserve announced on Sunday it would drop interest rates to zero and buy at least $700 billion in government and mortgage-related bonds as part of a wide-ranging emergency action to protect the economy from the impact of the coronavirus outbreak.
• The Fed, led by Chair Jerome H. Powell, effectively cut its benchmark by a full percentage point to zero. The benchmark U.S. interest rate is now in a range of 0 to 0.25 percent, down from a range of 1 to 1.25 percent.
• In the coming months, the Fed will purchase at least $700 billion more in bonds as part of its new quantitative easing. The majority of the buying, at least $500 billion, will be U.S. Treasury bonds. The rest will be mortgage-backed securities, an effort to stabilize home loans.
You are a fixed income securities Manager and Jayden is your client. He read the news but could not figure out how the “Federal Reserve could support the economy by cutting interest rates” and why government spends “$700 billion in Treasuries and mortgage-backed securities purchases”. He asked for your help:
a. Explain the action of increasing bond-buying and using interest rate as a tool to support market functioning and the flow of credit.
b. Use the Treasury yield data provided on Jan, 17, 2020 and March, 18, 2020 and explain how does the COVID-19 outbreak affect the Treasury yields, Treasury curve and the Treasury bond price?
(Hint: Excel line chart can be used to draw the yield curve)
c. Using the relevant information in the table to calculate the issuing price of the following U.S. Treasury bond.
Principal / Coupon Information Issuance Details
Maturity Date 15-Feb-2023 @ 100*00% Issue Date 18-Feb-20
Principal / Coupon Currency USD / USD Bond Yield 1.43%
Coupon Type Fixed:Plain Vanilla Fixed Coupon Announcement Date 05-Feb-2020
Coupon Frequency Semiannually Country of Issue United States
Current Coupon / Next Pay Date 1.50000 / 15-Aug-2020 Market of Issue Domestic
Dated / First Coupon 15-Feb-2020 / 15-Aug-2020 Underwriters —
Amount Outstanding 63,030,790,100 USD Country of Risk United States
Par Value / Min. Denomination / Increment 100.00 / 100.00 / 100.00 USD Original Issue Amount 39,007,715,400 USD
Floating Rate Note No Total Issue Amount 63,030,793,300 USD
Irregular Coupon None Total Price to Public —
Inflation Index Linked No Auction Date 12-Feb-2020
Principal Index Linked No Oversubscription in %
Data source: Refinitiv Eikon
(4 + 3 + 3 = 10)
The international travel industry faces a wide spread shutdown over Coronavirus fears after airlines announced new flight reductions and more countries introduced travel bans and isolation requirements. Qantas Airways and American Airlines try to get some loans to support the company’s near-term liquidity requirements. They approached some local banks and the table show the three-year fixed borrowing costs to Singapore Airlines (in SGD) and American Airlines (in USD). In the meanwhile, the foreign exchange markets are experiencing elevated volatility amid the spread of coronavirus. Two companies having different views on the currency movements. The coronavirus crisis has sent the Singapore dollar to its 3-year lowest level since May 2017, American Airlines holds a view that the Singapore dollar will maintain the low level for a while. Whereas Singapore Airlines believes the US dollar will depreciate as the US outstripped China with the most infections and there is no signs of a slowdown.
American Airlines 4% 4.5%
Singapore Airlines 3.5% 3%
* Quoted rates have been adjusted to reflect the differential impact of taxes. Assume the amounts required by the two airlines are roughly the same at the current exchange rate.
a) What are the comparative advantages for American Airlines and Singapore Airlines, respectively? American Airlines and Singapore Airlines want to borrow at which market, respectively?
b) Based on your answer in part (a), design a swap that will net the financial institution 0.2% per annum. Make the swap equally attractive to the two companies.
(4 + 6 = 10 marks)
Several countries have already stepped in to help airlines that have seen demand decimated almost overnight by the coronavirus outbreak, with the United States offering $58 billion in aid. Qatar Airways is one of few airlines continuing to maintain scheduled commercial passenger services. Thus Qatar expects to purchase two million gallons of jet fuel in six months and decides to use heating oil futures for hedging.
a. What risk exposure does Qatar have? What position should it take if Qatar wants to use heating oil futures to hedge the exposure?
b. Use the data provided to calculate the optimal hedge ratio if Qatar uses heating oil to hedge its position in jet fuel? Briefly explain the meaning of the ratio.
c. The heating oil futures contract size is 42,000 gallons per contract, what is the optimal number of futures contracts with no tailing effect?
(2 + 4 + 4 = 10 marks)
• The stock market has responded to the COVID-10 pandemic with worry volatility, as traders have panic – sold out of fear.
• The market has reacted to recent unpredictability with large drops, triggering a market wide circuit breaker four times in March. The safeguard pauses trading for 15 minutes in hopes the market will calm.
• The U.S. Securities and Exchange Commission mandated the creation of market-wide circuit-breakers to prevent a repeat of the Oct. 19, 1987 market crash, in which the Dow plunged 22.6%. Since then, they have only been triggered once in 1997 before the four times this March.
The COVID-19 Pandemic has resulted in country wide lockdowns and business closures all around the world. People spend a significant amount of time at home and many companies allow their staff work from home. As a result, streaming services and collaboration player have witnessed a surge in demand. As a hedge fund manager (Speculator), you have your own view on Netflix (NASDAQ:NLFX) and Zoom video (NASDAQ: ZM) for the next one month given the company’s performance over the past three months and the uncertainties related to the COVID-19 (suppose now is April). At present, you don’t own any shares, but you still want to make profit during this period. Answering the following questions based on the information given above.
a. You are a hedge fund manager and you have your own view on the future price movements of Zoom and Netflix. You would like to demonstrate to your investor how do you use a combination of call/put option and underlying stock to make profit. In your answer, (i) explain the reasoning of your expectation on future price movements and (ii) based on your expectation, choose from the following trading strategies that can make a profit.
(Assuming short selling is allowed in the market. Your role as a speculator is to make profit rather than holding the underlying stock).
Potential Trading Strategies
i. Buy call option and short sell stock
ii. Buy put option and short sell stock
iii. Buy stock and buy call
iv. Buy stock and buy put
v. Sell call option and short sell stock
vi. Sell put option and short sell stock
b. According to your selection of call option/put option in part (a), calculate the price of the option you selected, suppose the Netflix is on a non-dividend-paying stock and the stock price and strike price are given in the question, the risk-free interest rate is 3% per annum, the volatility is 30% per annum, and the time to maturity is three months.
NFLX Date Stock Price Expiration Date Strike Price 1 Strike Price 2
Call April 03, 20 361.76 August 22, 2020 355 380
Put April 03, 20 361.76 August 22, 2020 355 380
(Hint: You only need to calculate one option price thus you need to choose the appropriate strike price based on your opinion in a).
(5 + 5 = 10 marks)
James has seen the market turmoil sparked by coronavirus and decided to put his money in the safe-haven investments. As his investment adviser, you have told him “Don’t put all your eggs in one basket”. Thus he is considering investing in a portfolio consists of a $40,000 investment in Gold and a $60,000 investment in Silver.
a. What is the daily volatility for gold and silver?
b. What is the 10-day 97.5% value at risk for the portfolio?
c. By how much does diversification reduce the VaR?
(Hint: Use the daily price data to calculate the daily volatility of gold and silver, respectively. Also, calculate the correlation of coefficient between their returns.)
(2+5+3 =10 marks)
Such a cheap price for your free time and healthy sleep
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