<@ | Lupane State University snag es gh Raeto FACULTY OF COMMERCE DEPARTMENT OF ACCOUNTING AND FINANCE BACHELOR OF COMMERCE HONOURS DEGREE IN ACCOUNTING AND FINANCE PART IV. FIRST SEMESTER EXAMINATION RISK ANALYSIS AND MANAGEMENT [COAF 4106] NovemaeR 2019 DURATION: 3 HOURS INSTRUCTIONS “Answer Question 1 from Section A and any THREE questions from Section 8 Begin each question on anew page Please indicate the study format (Conventiona/Block/Paralel! on the cover of your answer script. INFORMATION 1, Matks per question re as indicated, 2. Questions may be attempted in any order, 3. Credit willbe given for showing all appropriate wo ‘This paper consists of printed pagesSECTION A (COMPULSORY) QUESTION 1 [40 Marks} You have a portfolio of $450 500 000 that mirrors the S&P 500 and you are concerned about the volatility of the stock market. You have decided to hedge using the stock market index futures. Suppose the 3 month index futures price is 1278 where each futures contract i $400 times the index, current index valu is 1219, risk fee interest rate is 7.4%, dividend yield on index s 1.8% and portfolio beta is 1.4 At maturity the index is 1206 and futures price is 1218, i. What hedging strategy is needed to cover the exposure? 1B Marks} li. Show the hedged position atthe end of three months. [5 Marks} itis mow late June and ADH Banks planning to invest ETGSBS 500.000 in 90 day bank bills in3 months’ time. The bank is concerned that the yields might fall and has to protect the return on its investment by hedging using 90 day bank bill futures. At end of June, the ‘September bank bill futures contracts trading at 92.66 and the bank bill yields are 7.34% i. What risk isthe bank most concerned with? Show the effects the rsk has on its portfolio. {3 marks) li, How would the bank construct an anticipatory hedge using bank bill Futures? (2 marks) fi, What would be the outcome of the hedge ifn late March the bank yields have fallen to 4.55%, and the September bank bl futures contract is trading at 95.55? [5 marks] ‘A’bank has advanced a 4 year loan to a company whose assets are currently valued at RTGS660 560. The loan isthe only debt in the capital structure of the company and the current Treasury bill rate is 10.5%, Standard deviation (o) = 36.5% and the leverage ratio. (8) = 64%, The bank s concerned about the possibility of credit loss asa result of default by the company. Consequently it decides to buy aputon the assets ofthe company. How much will the bank have to pay in order to eliminate creit risk? {5 Marks) itis July and a milling company decides t will have to buy 955 000 bags of grain in October ‘of same year. The company is worried the price of wheat might significantly rise before Page20f8‘they purchase and thas decided to hedge against price increases using grain futures that currently rade for delivery every month with a contract ie ofS thousand bags. Suppose the company decides to use December futures and the futures price on 15 July s TGS38.55 a.bag and the company closes out its postion on 20 October when the spot and futures prices are RTGSSS.25 and RTGSS3.65 per bag respectively |. How should the company construct a hedge using the futures contract? fa Marks) 4i, Calculate the total price paid forthe grain [2 Marks} ‘Over the past 680 days, you have managed a portfolio werth RTGS6 $50 000. The records show that over the period of 680 days, an average daily return of return of 0.78% was earned with a standard deviation of 1.25%, Your estimations show that over the same period there is a 5% likelihood that the portfolio might decrease by 1.85% over a day. ‘Assuming the future distribution ofthe returns will follow the previous pattern, calculate the 680 day value at risk for the company at 95% confidence level. [3 marks} You own a portfolio that is valued at RTGS425 600. Your financial advsor has indicated over a period of 36 months, the returns on the portfolio ere normally distributed with an average of 2.55% and a standard deviation of RTGS15 145. Calculate the value at risk for the portfolio over a time horizon of a month and confidence level of 99.2%, (3 Marks} Suppose a Zimbabwean farmer has, on 20 January, struck a deal to supply tobacco to a South African client worth R8BS.000 000 and payment would be made at the end of June. The farmer is concerned withthe potential volatility inthe Rand value and has decided to hedge against the fallin the Rand using the June Futures contracts. Suppose each contract Is for the delivery of R500 000. On 20 January the futures price is RTGS/R 1585. fat tend of June the futures and spot prices are RTGS/R = 0.1355 and RTGS/R = 0.1315 respectively, calculate the effective price obtained by the farmer. [3 Marks} Page 30f8fh. Youhave inherited a portfolio of ATGS6SS milion bonds consisting of A-ated bonds (35%) and B-rated bonds (26%) C- rated bonds (18%) and D- rated bonds (21%). Assume that the one-year probabilities of default forthe bonds are A rated: 3.2%, B- rated bonds: 3.1%, C rated bonds: 4.3% and D- rated bonds: 5.6% and that they are independent. if the recovery value for the bonds in the event of default is 55%, 4596, 60% and 56% respectively, what is the one-year expected credit loss from this portfolio?[3 Marks] SECTION B (ANSWER ANY THREE QUESTIONS IN THIS SECTION) QUESTION 2 [20 marks} a. Explain how you would establish the internal context during the risk management process [5 Marks} ». Explain any two advantages of using Value at Risk to measure market risk [4 Marks] v ‘Risk management combines the top-down and botton-up processes with the horizontal processes. How is the top down process ferent from the horizontal process? [3 Marks) 4. Risk identified may be retained and managed through risk financing, risk neutralization, transferred using traditional insurance, derivatives, stuctured insurance or structured finance. Show how you would transfer risk using structured finance, [4 Marks) ‘Credit analysis isthe most important step in the lending process as it determines the credit standing of a potential borrower (individual or corporate) and more so given that banks provide loans based on the credit information of the borrowers as well as their businesses. How would you use the LAPP technic to evaluate the credit worthiness of a credit applicant? [4 Marks} e Page of 8QUESTION 3 [20 marks} Operational risk is often the second most prevalent risk for banks, after credit risk, in terms of financial exposure. The risk includes direct, and indirect loss resulting from inadequate or failed internal processes, pe and systems, o from external evens. What measures can an institution putin place toaddress each ofthe sources of Sanne © above? [e Marks) ». To absorb losses emanating from operational risk, capital reserves are often used. The firm can estimate the expected losses as wells the amount of capital required to support unexpected losses using the distribution of operational losses, With the aid of an appropriate diagram, explain how expected losses difer from unexpected losses {6 marks} Liquidity risk can result from asst liquidity risk or funding liquidity rsk though the two are related. How does asset liquidity risk fer from funding liquidity isk?{6 Marks) QUESTION 4 [20 marks] a. Trace the sources of financial distress for the past six years among Zimbabwean banks. [10 Marks} Discuss the challenges faced by Zimbabwean financial institutions in adopting the Basel framework, [10 Marks) QUESTION 5 [20 marks) a. Youhave been appointed tothe Asset and Liability Management Committee of ADG Bank, ‘Mr. Bhebhe, the chairman of the board of directors is not familiar with bank operations and neither is he knowledgeable about risk management. He has thus asked you to advise him on what the committee is about. Explain to Mr Bhebhe; |. What Asset Liability Management is about. [2 marks} li, Why Asset Liability Management is critica to banks, [5 Marks} li, The role ofthe Asset Liability Management committee, [8 marks) Page 5 of 8iv. Which two major risks affect balance sheet management. {5 Marks} END OF EXAMINATION PAPER Page 6 of 8Standard Normal Probabilities “Table entry fr zs the area under the standard norma cue twthe lentofz Be ee S040 $080 5120 5160 51995239 ‘SA380"00.S478° 55175557 5595 5536 583258715910 S948 S987 6126 (03 S.61792 6247" .6255) 16293 (630162686106, 04 16591 6628-6564 6700 6736 5772 os: {69509 16985, 7019" Jose, 7088-7123 06 9173247357 738974227454 07 FOAL 7692 VN ZETRIN” 7708" 7734 7164 08 7310 79677995 802301 0.9. 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