Artificial Intelligence (AI) Bank wants to obtain the DEAR (Daily Earnings at Risk) on its trading portfolio. The portfolio consists of the following securities. Fixed-income securities:

AI Bank 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 7.5%. The historical mean change in daily yields is 0% (zero percent), and the standard deviation is 22 basis points (BPs).

AI Bank 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%. The price volatility if the potential adverse move in yields is 65 BPs.

Foreign exchange contracts:

AI Bank 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, AI Bank finds that the volatility or standard deviation () of the spot exchange rate was 55.5 BPs.

Equities:

AI Bank 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 BPs.

Correlations (ij) among Assets are given below: _______________________________________________________________________________ Six-year zero-coupon 12-year zero-coupon /$ U.S. stock index Six-year, zero-coupon - 0.75 -0.2 0.40 12-year, zero-coupon - - -0.3 0.45 /$ - - - 0.25 U.S. stock index - - - -

a. Calculate the DEAR (Daily Earnings at Risk) of this trading portfolio of AI Bank.

b. If the standard deviation of the stock market index increases to 325 basis points, what will happen to the AIs DEAR? Explain.