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Question 2 Consider the following discrete probability distribution of payoffs for two securities, A and B, held in the trading portfolio of a bank: Probability

Question 2

Consider the following discrete probability distribution of payoffs for two securities, A and B, held in the trading portfolio of a bank:

Probability Payoff A

55.00% $120m

44.00% $95m

1.00% -$1,100m

Probability Payoff B

55.00% $120m

44.00% $100m

0.30% -$1,100m

0.70% -$1,414m

a) What is the expected return of security A and the expected return of security B?

[3 marks]

b) According to VaR (Value at Risk), which security is adding more market risk to the bank's trading portfolio? Make sure your calculations are clear and explain your answers.

[5 marks]

c) According to ES (Expected Shortfall), which security is adding more market risk to the bank's trading portfolio? Make sure your calculations are clear and explain your answers.

[5 marks]

d) Compare your answers in items b) and c) and discuss the advantages and pitfalls of each of the two risk measures.

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