a). Consider a portfolio of 20 domestic stocks with $10m in each stock.

Explain how you can use the variance-covariance (VCV) method and the single index model (SIM) to calculate the Value at Risk (VaR) for the above portfolio at the 5th percentile, over a 10-day horizon. Explain any assumptions you make and the possible risks in the hedge.

(You may use illustrative numbers and equations where appropriate).

b)You hold 100 long calls (on stocks-XYZ) each with a delta= +0.8, gamma= 0.1 and vega= 0.15. You also hold 50 stocks-XYZ.

Explain the steps required when using Monte Carlo Simulation (MCS) to obtain the 10-day VaR of this portfolio (at the 1stpercentile).

Explain the source of any potential weaknesses in this approach.