Finance & Risk Management Concepts with Techniques - Accounting And Finance Assignment Help

Assignment Task

Overview
The task you are given is to estimate the market risk for a 2 year Commonwealth government bond, held on September 2 , 2021 (you are working out the risk position assuming that you own the bond at the close of trading the previous day). You will do this by estimating the Value-at-Risk for the bond. This will require you to choose the best VaR model by backtesting several methods to determine the most reliable for the task at hand.
Description
You will be asked to calculate the following;
10 day VaR for the bond at a confidence level of 99%.
Note: This risk estimate applies to the next 10 trading days from September 2, 2019 until September 13, 2019 (i.e. – it should be a forecast of risk).
Based on what you have learnt from EFB344, you are considering several options for how to compute this risk measure, a) the normal distribution using the EWMA for volatility, or b) a normal distribution based on a rolling window for volatility, and c) historical simulation using a rolling window. All three methods require choosing parameters to assign weight to past data, ? for the EWMA and the window length for the rolling windows. You will consider the following;
Normal Distribution (EWMA) ?=0.94Normal Distribution (RW) Rolling window with 252 trading days.
Historical Simulation (HS) Rolling window with 252 trading days.
This leaves you with three possible models that could be used to provide the VaR measure asked for above. You must choose the most appropriate model and report the associated 10 day VaR. To inform your decision of which to use, you are going to consider the recent historical performance of all three models in calculating 1 day VaR at the confidence level of 99%. You will do so by first examining the frequency of instances when the VaR was exceeded by the observed loss over the period for which you are provided with historical data.
You will then evaluate the appropriateness of these frequencies over time relative to the Basel traffic light levels discussed in lectures. Based on this performance, select the best model and report the required VaR(10, 99%) for September 2, 2021.
Bond Pricing details and Risk management assumptions
The bond you are dealing with has two years to maturity, with semi-annual coupons at a rate of 2.5% per annum. The face value of the bond is $1,000,000. When pricing the bond you are to assume that you use a single discount rate for all cash flows (you are provided with data for this rate). This is equivalent to assuming a flat yield curve that always moves in parallel shifts.
Presenting your results
You are to conduct your analysis in a copy of the Excel file “Assignment_Part_A – Data and Results.xlsx” provided on Blackboard. This file contains a tab with the raw data for the discount rate as well as a front page for you to summarize your results. All working is to be contained in the subsequent tabs.
The front tab asks you to provide the following
Your name and Student number
The exceedance probabilities for the three models above.
A graph summarizing the Basel Traffic Light results (such as the one shown in lecture 3).
Which of the models above is your preferred model based on the backtesting results.
The final VaR(10,99%) for the portfolio based on your preferred model.
An evaluation of the relative performance of the two models and a clear justification of which model is superior based on your backtesting. This is essentially a discussion of how you should interpret the backtesting results in order to select the most appropriate model. This should be no more than 300 words.
Your excel file should be formatted in a reasonably clear way, so that someone who was given the same job after you would be able to understand your working and replicate what you have done.
Details of Submission
Submit the Excel file through the assignment portal that is available on the EFB344 Risk Management and Derivatives Blackboard site. Please include your name and student number in the file name of your document. Note that the portal will close after the due date and that any assignments that have been granted official extensions must be emailed to Steve Thiele (sr.thiele@qut.edu.au).
Also note QUT’s late assignment policy:
Late Assignment + No Extension = 0%
Additional Notes and Instructions
I have sourced the raw data on the yield for 2 year Commonwealth government bonds for you from the RBA.
Your excel spreadsheet must contain the formulas that you have used for all calculations (i.e. – don’t paste the values for the calculations).
There is an Excel file available on blackboard (called “Excel guide.xlsx”) that includes instructions for how to do several useful things in excel. It also includes some informative examples which might be of interest. Please look at this file.
A few hints that will help stop people going down the wrong path;
You have been provided with a history of discount rates for a 2 year government bond. From this you should be able to work out what the price and duration of a new 2 year bond would have been every day historically. You will then be able to work out what the VaR would have been for those bonds every day through that history, using the sensitivity of the bond to a change in discount rates and your model for the distribution of the daily changes in discount rates (you are asked to consider 3 such models). These daily VaR estimates can then be compared to the realised change in the bond price each day to perform the backtest (see lecture 3 for an example of the backtest for a stock).
In order to perform the backtesting, you will have to work out the bond price and modified duration many times. Ideally you will want to do this conveniently using a single cell in your Excel spreadsheet. The Excel guide mentioned above gives examples for how this can be done using the MDURATION and PV functions.
The duration formula gives a result measured in the number of periods. Hence, if you have semi-annual coupons, you must divide your duration by 2 to convert it to years. This is necessary if you are using it to measure sensitivity to changes in a per annum interest rate.
Remember that we are assuming that daily changes in the discount rate (i.e. – rate today minus rate yesterday) are normally distributed or derived using the historical simulation method for changes in the discount rate. You are not considering the returns calculated from the rates but simply the changes in the rate (this is different from the stock example).
In order to implement the historical simulation method for the VaR(1,99%) of a bond, you are trying to find the historical daily change in the interest rate that is worse than 99% of changes for that window of data, and then multiplying that by the sensitivity of the bond to changes in the discount rate.
I am happy for you to use either the modified duration approach or the repricing with a basis point shift approach. Both methods were presented in lecture 4 and should give similar results.
You can assume that the mean change in discount rates is zero.
You should initialise your EWMA using the variance of the first 252 changes in the discount rate. This will enable you to produce the same number of potential exceedances for both models.
While you have around seven years of data, your will only be able to produce around six years of VaR estimates, and your Basel Traffic lights can only be calculated for around five years. This should become clear as you go through the process of calculating what is asked for.
If you have any questions about any of this, please ask them!!!!
Criteria and Standards Sheet for Assignment Part A (30 marks)
Marking Criteria High Distinction Distinction Credit Pass Fail Mark
KS (1.1): Demonstrate and apply integrated discipline (including technical) knowledge
SubjectKnowledge Demonstrates comprehensive understanding of relevant finance and risk management concepts and techniques. Demonstrates a developed understanding of relevant finance and risk management concepts and techniques. Demonstrates a developed understanding of relevant finance and risk management concepts and techniques but with a few errors. Demonstrates an adequate understanding of relevant finance and risk management concepts and techniques. Insufficient or inaccurate understanding of relevant finance and risk management concepts and techniques. /17

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