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MANM279:  Risk Management

Semester 2 2021-22

Question 1

In 2020 there was a sudden drop of market liquidity when lockdowns were first declared. Discuss and explain with reference to examples covered in class whether banks were in a stronger or weaker position to withstand that shock compared to the liquidity shock of 2008.  (15 marks)

[Total 15 marks]

Question 2 

Gold Plc is a British gold mining company with a GBP1 billion bond in issue and a maturity date of 31 May 2032. The company has some activity in Russia, but most of the extraction happens outside of Russia. There is an active market for CDSs in Gold Plc bonds.

a) Are the CDS spreads in Gold Plc bonds likely to be higher in 2022 than they were in 2021 or lower? Why?   (5 marks)

b) You own GBP1 million of Gold Plc bonds. You obtain a quote for 5-year cash settled CDS with a premium of 80 bp per annum paid semi-annually. Calculate the cash flows under this CDS if a default occurred after 1 year and 5 months and the auction-determined recovery rate is 30%. Draw a diagram to illustrate.         (10 marks)

[Total 15 marks]

Question 3

a) Explain the concept of credit risk and give one example of how to manage it.  

(5 marks) 

b) If a company takes a very large borrowing, can this cause an increase to the liquidity risk of this company? Why? (5 marks)

[Total 10 marks]

Question 4

A bank has the following balance sheet (values in millions of pounds):

a)    Calculate the bank’s NSFR and state whether or not is meets the NSFR requirement.

(5 marks)

b)   Calculate the value of additional Tier 1 Capital needed to meet the NSFR assuming that the additional capital will be held in cash.

(5 marks)

c) Repeat part b) above assuming that the additional capital will be used to fund Mortgage products instead of being held in cash.

(5 marks)

[Total 15 marks]

Question 5

Based on the following information, calculate the optimal hedge ratio and the number of futures contracts required:

• The correlation between the futures and spot price movements for an asset is 0.9

• The standard deviation of the asset spot price is 4.0% and the asset value is $5,000,000

• The standard deviation of the price of the asset futures contract is 5.0% and one asset futures contract is priced at $100,000.      (10 marks)

Question 6

You are given the following information:

1-day 99% VaR of each position within the portfolio:

Correlation data:

Required:

a) Define Value at Risk (VaR) and stressed VaR and explain why Basel II.5 regulations introduced stressed VaR following the Global Financial Crisis (GFC) of 2007-08.

[5 marks]

b) Using a normal distribution approximation, calculate the 1-day 95% VaR for the above portfolio.

 [20 marks] 

c) Explain how VaR is calculated from historical data and why this method is preferred by banks rather than using a normal distribution.

[10 marks]

[Total 35 marks] 

TOTAL 100 MARKS