Question
Consider a firm with a trading book valued at $100 million. The return on these assets is distributed normally with a yearly standard deviation of
Consider a firm with a trading book valued at $100 million. The return on these assets is distributed normally with a yearly standard deviation of 25%.
aSuppose the firm can liquidate all of the assets immediately in liquid markets. How much capital should the firm have so that 99 days out of 100, the firms return on assets is high enough that, after liquidating its portfolio, it would have capital left? (10 points)
bSuppose the firm is in a situation where it cannot liquidate its portfolio for 5 days. How much capital does it need to have so that 95 5-day periods out of 100, it ends the period with positive capital if it has to liquidate its portfolio? (10 points)
cHow does your answer to (b) change if the firms trading book has an annual expected return of 10 percent? (10 points)
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