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Consider a bond portfolio: $10 million in a 5-Year issue paying 7% coupon paid annually; and $10 million in a 2-Year issue paying 5% coupon

Consider a bond portfolio: $10 million in a 5-Year issue paying 7% coupon paid annually; and $10 million in a 2-Year issue paying 5% coupon paid annually. All bonds are selling at par. Portfolio duration is 3.1 years. Spot rates for the next five years are 4.5%, 5.6%, 6.2%, 6.9%, and 7.5%. Relevant zero coupon bonds have the following relative VaR values:

Term (Year)

Risk (%)

1

0.4696

2

0.9868

3

1.4841

4

1.9714

5

2.4261

Use Principal Mapping method to estimate VaR of this portfolio. Describe resultant mapped portfolio, and calculate portfolio VaR.

Use Duration Mapping method to estimate VaR of this portfolio. Describe resultant mapped portfolio, and calculate portfolio VaR.

Use Cash Flow Mapping method to estimate VaR of this portfolio. Describe resultant mapped portfolio, and calculate undiversified portfolio VaR.

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