Question
An FI wants to obtain the DEAR on its trading portfolio. The portfolio consists of the following securities. Fixed-income securities The FI has a $1
An FI wants to obtain the DEAR on its trading portfolio. The portfolio consists of the following securities.
Fixed-income securities
The FI has a $1 million position in a six-year zero-coupon bond with a face value of $1,543,302. The bond is trading at a yield to maturity of 7.5%. The historical mean change in daily yields is 0.0%, and the standard deviation is 30 basis points. Suppose the yield changes are normally distributed and an adverse change is a 1% chance.
Foreign exchange contracts
The FI has a 2.0 million long trading position in spot euros at the close of business on a particular day. The exchange rate is 0.80/$1, or $1.25/, at the daily close. Looking back at the daily changes in the exchange rate of the euro to dollars for the past year, the FI finds that the volatility or standard deviation () of the spot exchange rate was 50 basis points (bp).
Equities
The FI holds a $3 million trading position in stocks that reflect the Australian stock market index (e.g., All Ordinaries). The = 1. Over the past year, the standard deviation of the stock market index was 200 basis points.
The correlations among the three assets are:
| Fixed-income securities | Foreign exchange contracts | Equities |
Fixed-income securities | 1 | -0.2 | 0.4 |
Foreign exchange contracts |
| 1 | 0.1 |
Equities |
|
| 1 |
a. What is the DEAR of the fixed-income securities?
b. What is the DEAR of the foreign exchange contracts?
c. What is the DEAR of the equities?
d. Calculate the DEAR of this trading portfolio.
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