An FI wants to obtain the DEAR on its trading portfolio. The portfolio consists of the following securities.

Fixed-income securities:

i) The FI has a $1 million position in a six-year, zero bonds with a face value of $1,543,302. The bond is trading at a yield to maturity of 7.50 percent. The historical mean change in daily yields is 0.0 percent, and the standard deviation is 22 basis points.

ii) The FI also holds a 12-year, zero bond with a face value of $1,000,000. The bond is trading at a yield to maturity of 6.75 percent. The price volatility of the potential adverse move in yields is 65 basis points.

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 percentage 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 55.5 basis points (bp).

Equities:

The FI holds a $2.5 million trading position in stocks that reflect the U.S. stock market index (e.g., the S&P 500). The = 1. Over the last year, the standard deviation of the stock market index was 175 basis points.

Correlations (_ij) among Assets

	Six-Year, Zero-Coupon	12-Year, Zero-Coupon	/$	U.S. Stock Index
SixYear, Zero-Coupon	-	0.75	-0.2	0.4
12-Year, Zero-Coupon	-	-	-0.3	0.45
/$	-	-	-	0.25
U.S. Stock Index	-	-	-	-

1. Calculate the DEAR of this trading portfolio.

2. If the correlation matrix changes as follows, what will the FIs DEAR be? Explain the change in DEAR.

	Six-Year, Zero-Coupon	12-Year, Zero-Coupon	/$	U.S. Stock Index
SixYear, Zero-Coupon	-	0.85	-0.1	0.5
12-Year, Zero-Coupon	-	-	-0.2	0.55
/$	-	-	-	0.35
U.S. Stock Index	-	-	-	-

3. If the standard deviation of the stock market index increases to 325 basis points, what will the FIs DEAR be? Use the original correlation matrix. Explain the change in DEAR.

4. If the FIs FX position were changed to 4.0 million, what will the FIs DEAR be? Explain the change in DEAR. Use the original correlation matrix and the original standard deviation of the stock market index.