Market Value Position

1. A bank has a $2 million market value position in a 6-year, zero coupon bond.The bond is yielding 8%.The mean change in the daily yields of the 6-year, zero coupon bond has been 2 basis points over the past year with a standard deviation of 10 basis points.Using these data and assuming the yield changes are normally distributed:

(a) What is the highest yield change expected if a 99 percent confidence level is required?

(b) What is the daily earnings at risk (DEAR) using a 99 percent confidence level?

(c) Please interpret in words the meaning of the DEAR you calculated in part (b).

2. Bank of Detroit has estimated that its 1 million euro position is subject to market risk.The spot exchange rate is €1=$1.15.Over the past six months, the spot exchange rate has a mean 5 basis points and a standard deviation 40 basis points.Determine the bank’s DEAR for this € position using a 99 percent confidence level.

3. Suppose a bank holds a $2 million trading position in stocks that has a beta 2.0.Suppose that the daily changes in returns for the portfolio have a mean 0 and standard deviation 1%. Determine the bank’s DEAR for this equity position using a 99 percent confidence level.

4. What is prepayment risk? What are the two primary factors that cause early payment?

5. What is credit risk?What are the five Cs of credit?

6. What are the limitations of the RiskMetrics model?

7. What is a total return swap? How does a total return swap differ from a credit default swap?

8. Use the following market-value balance sheet information to answer the following questions.

Assets (in millions)Liabilities (in millions)___

Assets Duration=8 years$1000Liab Duration=4 years$850

Equity$150

• What is the institution’s leverage-adjusted duration gap?
• Now the interest rate is 6%.If next year the interest rate shifts upward 50 basis points (i.e., 0.5%), what is the impact on the FI’s market value of equity?

c. Suppose that the bank macrohedges using Treasury bond futures that are currently priced at 98.(One Treasury bond futures contract has face value $100,000).Assume the Treasury bond has a duration of 5 years.How many Treasury bond futures contracts would be needed?Should the bank buy or sell Treasury bond futures, why?