Sunshine bank decides to measure its market risk exposure by calculating the daily earnings at risk (DEAR) on its trading portfolio. Its trading portfolio consists of the following assets:

PART A:

(1) Fixed-income Bonds:

The bank holds a 10-year zero coupon bond with a face value of $3,600,000. The bond is trading at yield to maturity of 3%. The potential adverse move in yields is 0.0025.

If a 90% confidence limit is required, compute DEAR for Fixed Income.

(2) Equities:

The bank holds a $7 million trading position in stocks that reflects the stock market index (the = 1). Over the last year, The historical mean change in the stock market index was 0.0 per cent and the standard deviation of the stock market index was 1.6%

If a 90% confidence limit is required, compute DEAR for equities.

(3) Foreign exchange:

The bank has a net long position of 7.5 million Euros (7.5M) at the close of business on a particular day. Assume the exchange rate is 1.63 USD = 1 at the daily end. Looking back at the daily changes in the exchange rate of the euro to USD for the past year, the bank finds that the historical mean change in daily exchange rates was 0.0 per cent and the volatility or standard deviation () of the spot exchange rate was 0.66%.

If a 90% confidence limit is required, compute DEAR for FX.

PART B:

(4) Assume correlations (_ij) among assets are as follows

	Foreign exchange	Stocks
Bonds	-0.5	0.4
Foreign exchange		0.3

Compute 10 day Value at Risk (VAR) of banks trading portfolio using a 90% confidence level and explain how the VAR position would be interpreted.