Question 2 (6 points) Superfin (a Singapore-based) financial institution, has 125 million foreign assets denominated in euros. These are loans issued at 8% per annum that mature in 6 months and interest is to be paid at the end of six- month period once. From its trading activities, Superfin has a portfolio of zero-coupon German bonds that will pay their face value in 6 months: that is a long position of 78.75 million and a short position of 100 million. You are given the following report: Spot Exchange Rate (S$ per ): 1.600 Forward rate: 180-day (SS per ): 1.620 Historical volatility of spot exchange rate (per annum) 18.0% Spot Exchange Rate change (relative to previous month) -20.0% (return) Superfin can borrow at 7.5% Superfin can borrow $$ at 6.5% Cost of Equity 10% Over-The-Counter Options Strike Premium Call Options 180-day 1.655 (5$ perc) 1.00% Put Options 180-day 1.625 (5$ perc) 1.20% All interest rates are on a per annum (po) basis SS Singaporeon dollar (SGD): domestic currency a) Use the historical volatility estimate in the table above and estimate the monthly earnings at risk (in % terms and SS terms) of Superfin's overall position at 95% confidence level (VaR). If the quant desk uses the Riskmetrics model (Exponentially Weighted Moving Average with A = 0.94) to obtain a volatility forecast for next month what is the next month's earnings at risk (in % terms and S$ terms) at 95% confidence level (VaR)? Is it different than your previous estimate and, if yes, how by much and why do you think that is? (1 points) b) Calculate the relative costs as well as the possible outcomes of the forward, money market and option hedging strategies available to Superfin in order to cover its foreign exchange risk. If inflation in Singapore is expected to be lower than EU in the coming months, what hedge is in the company's best interest? What if vice versa, i.e., inflation in Singapore is expected to be higher than EU? Can a strategy be formed with all two options together? If yes, what is the cost of the hedge and what the overall cash flow if the exchange rate goes to i) 1.7.) 1.8, mi) 1.6 or iv) 1.5? (3.5 points) c) of the 125 million foreign assets, 25 million represent a specific (8% interest rate) that Superfin issued to European corporation "EUC 10 years ago. EUC recently had an alarming audit control and you are concerned about the likelihood that EUC will default soon just when the principal of the loan is due. The cost of funds of the loan stands at 6.5% per annum while all other fees sum to 1%. EUC has assets of 80 million and total debts of 66 million. The volatility of the firm's assets is estimated at 10.92 million while the loss Given Default (LGD) is 5 million. Use the KMV framework to find the Expected Default Frequency (assuming a normal distribution for asset price movements), the loan's return and the unexpected loss (volatility of the default rote) (1.5 points) os Question 2 (6 points) Superfin (a Singapore-based) financial institution, has 125 million foreign assets denominated in euros. These are loans issued at 8% per annum that mature in 6 months and interest is to be paid at the end of six- month period once. From its trading activities, Superfin has a portfolio of zero-coupon German bonds that will pay their face value in 6 months: that is a long position of 78.75 million and a short position of 100 million. You are given the following report: Spot Exchange Rate (S$ per ): 1.600 Forward rate: 180-day (SS per ): 1.620 Historical volatility of spot exchange rate (per annum) 18.0% Spot Exchange Rate change (relative to previous month) -20.0% (return) Superfin can borrow at 7.5% Superfin can borrow $$ at 6.5% Cost of Equity 10% Over-The-Counter Options Strike Premium Call Options 180-day 1.655 (5$ perc) 1.00% Put Options 180-day 1.625 (5$ perc) 1.20% All interest rates are on a per annum (po) basis SS Singaporeon dollar (SGD): domestic currency a) Use the historical volatility estimate in the table above and estimate the monthly earnings at risk (in % terms and SS terms) of Superfin's overall position at 95% confidence level (VaR). If the quant desk uses the Riskmetrics model (Exponentially Weighted Moving Average with A = 0.94) to obtain a volatility forecast for next month what is the next month's earnings at risk (in % terms and S$ terms) at 95% confidence level (VaR)? Is it different than your previous estimate and, if yes, how by much and why do you think that is? (1 points) b) Calculate the relative costs as well as the possible outcomes of the forward, money market and option hedging strategies available to Superfin in order to cover its foreign exchange risk. If inflation in Singapore is expected to be lower than EU in the coming months, what hedge is in the company's best interest? What if vice versa, i.e., inflation in Singapore is expected to be higher than EU? Can a strategy be formed with all two options together? If yes, what is the cost of the hedge and what the overall cash flow if the exchange rate goes to i) 1.7.) 1.8, mi) 1.6 or iv) 1.5? (3.5 points) c) of the 125 million foreign assets, 25 million represent a specific (8% interest rate) that Superfin issued to European corporation "EUC 10 years ago. EUC recently had an alarming audit control and you are concerned about the likelihood that EUC will default soon just when the principal of the loan is due. The cost of funds of the loan stands at 6.5% per annum while all other fees sum to 1%. EUC has assets of 80 million and total debts of 66 million. The volatility of the firm's assets is estimated at 10.92 million while the loss Given Default (LGD) is 5 million. Use the KMV framework to find the Expected Default Frequency (assuming a normal distribution for asset price movements), the loan's return and the unexpected loss (volatility of the default rote) (1.5 points) os