Enterprise Risk Management

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Project Desciption

Assessment Question

Objective:

Assess the practical and theoretical understanding of the key concepts, debates, issues and tools presented in the module.

Coursework Description:

Section 1. VaR

Marks: 15% of the overall coursework mark.

Word limit: 500 words

1.1. Suppose the historical standard deviation of a stock index has been 0.6% per day, and an investor has a $10,000 investment in the index. Calculate the 1-day, 5% VaR in dollars.

(4 marks)

1.2. Provide two kinds of interpretation to the result in part 1.1.

(2 marks)

1.3. Suppose you invested $15,000 in the stock of XYZ company in early 2020. You have compiled the monthly returns on this stock during the period of 2015-2019, as given below.

2015 2016 2017 2018 2019
-0.0214 -0.0347 -0.1824 -0.0723 -0.1017
-0.0106 -0.0566 -0.0070 -0.1021 0.0264
0.0262 0.0158 0.0010 0.1114 0.1344
-0.1196 0.0862 -0.0648 0.2257 0.0786
-0.0313 0.0675 0.2378 -0.0043 -0.1772
-0.0362 0.0609 -0.0512 0.1867 -0.0953
-0.1137 -0.0203 0.1229 -0.0255 0.0978
0.0401 0.0100 -0.1156 0.1831 -0.1110
0.0129 -0.0230 -0.2416 -0.0360 0.1020
0.0652 0.1087 -0.2591 -0.0531 0.1099
0.1196 -0.1980 -0.0844 -0.0228 -0.0816
-0.0789 -0.0012 -0.0833 0.0170 0.0250

Using the historical method, calculate the 1% monthly VaR in dollars.

(3 marks)

1.4. List and describe three general limitations of VaR.

(3 marks)

1.5. Because VaR has certain limitations, managers will often back test their VaR models. In addition, there are measures that can be used as supplements to the regular VaR measure (i.e., supplement the information provided by VaR). List and describe three complementary measures that can be used as supplements to VaR.

(3 marks)

Section 2. Interest Rate Swap and Forward Rate Agreement (FRA)

Marks: 15% of the overall coursework mark.

Word limit: 500 words

Two companies, VIVA and ZEEK, consider borrowing funds for two years. They have access to borrowing for two years as specified in the table below.

Company Fixed Borrowing Floating Borrowing
VIVA 6% LIBOR + 30 bps
ZEEK 8% LIBOR + 80 bps

2.1. Briefly explain which company has an absolute advantage in both fixed and floating borrowing markets.

(2 marks)

2.2. Compute the borrowing rate differential between VIVA and ZEEK in each of the two markets.

(2 marks)

2.3. Discuss VIVA and ZEEK’s comparative advantages in the two markets. Then explain how an interest rate swap could help the two companies transform their liabilities.

(4 marks)

2.4. What is the total potential savings for VIVA and ZEEK if they enter into an interest rate swap? Suppose they split the total potential savings evenly, what is the net borrowing cost for each of the two companies? Assume no financial intermediary is involved in the interest rate swap.

(3 marks)

2.5. VIVA and ZEEK have been told that an interest rate swap is equivalent to a series of forward rate agreements (FRAs). Explain the difference between an interest rate swap’s settlement payment and an FRA’s.

(4 marks)

Section 3. Option and Futures

Marks: 15% of the overall coursework mark.

Word limit: 500 words

An investment management firm VUCA is concerned about the risk level of a client’s equity portfolio. In June 2020, the client has 60% of this portfolio invested in two equity positions: ABC and EFG stocks. VUCA’s research provides the following views on the two stocks.

  • ABC’s share price is very likely to go down in the next 3 months;
  • EFG does not have immediate substantial downside risk but its upside potential is likely to be limited.

Although the client refuses to sell her shares in either company, she has agreed to use option strategies to manage these concentrated equity positions over the next 3 months. The options available to construct the positions are shown in the table below.

Stock Shares Stock Price in June European Options Option Premium
ABC 325,000 $24.20 September 23.00 put $0.80
September 27.50 call $0.65
EFG 280,000 $33.00 September 31.50 put $0.85
September 34.00 call $1.20

3.1. Choose between covered call and protective put strategies to manage the risk exposure of ABC based on VUCA’s research. Then calculate the maximum profit and loss and the breakeven price.

(3 marks)

3.2. Choose between covered call and protective put strategies to manage the risk exposure of EFG based on VUCA’s research. Then calculate the maximum profit and loss and the breakeven price.

(3 marks)

VUCA also wishes to increase the beta for one of its portfolios under management from 0.95 to 1.20 for a 3-month period. The portfolio has a market value of $175,000,000. The investment firm plans to use a futures contract priced at $105,790 in order to adjust the portfolio beta. The futures contract has a beta of 0.98.

3.3. Calculate the number of futures contracts that should be bought or sold to achieve an increase in the portfolio beta.

(2 marks)

3.4. At the end of three months, the overall equity market is up 5.5%. The stock portfolio under management is up 5.1%. The futures contract is priced at $111,500. Calculate the value of the hedged stock portfolio ending value and the effective beta of the portfolio.

(4 marks)

3.5. Explain whether the above three strategies based on option and futures incur any credit risk.

(3 marks)

Section 4. Risk Hedging

Marks: 20% of the overall coursework mark.

Word limit: 500 words

As risk manager for EXPO corporation, you are assessing the firm’s various risk exposures to include in a regular semi-annual report to upper management. EXPO is a medium-size import/export firm located in Norwich, United Kingdom. Its primary sources for imports, which it sells in the UK and Eurozone, are located in China and Vietnam. It has customers throughout the world, but more than half of its exports go to the Africa. EXPO customarily borrows to cover funds tied up in exports. Further, EXPO has recently launched its own online B2B (Business-to-Business) platform.

4.1. Identify seven types of risk exposures you should report and provide a brief explanation for each risk exposure.

(14 marks)

4.2. Suppose the firm’s board needs your views on the trade-off of hedging against the identified risks. Briefly discuss what kind of value can be generated by risk hedging, when risk hedging is most likely to generate value and when it is least likely to do so.

(6 marks)

Section 5. Enterprise Risk Management

Marks: 35% of the overall coursework mark.

Word limit: 2,000 words

“Does Enterprise Risk Management Increase Firm Value?”

Write a 2,000-word discussion essay to answer this question by following the requirements below.

  • In addition to explaining the relevant theories, you should use empirical evidence (i.e., research findings) to back up your arguments.
  • Include at least 5 references to articles in credible academic journals or professional magazines/newspapers. These should be included at the end in a list of references. Do not include articles that you do not cite within your coursework or that you have not at least partly read.

(35 marks)

Important Coursework Requirements:

  • You should submit the coursework file electronically by naming your file with your student number.
  • The coursework must be word processed in Microsoft Word (or equivalent software). Font must be Times New Roman with a size of 12 points; character scale must be 100% and spacing and position should be normal (the default options); use normal margins (2.5cm on top, bottom, left and right); line spacing must be 1.5 lines with an extra line between paragraphs and headings; alignment must be justified; edit your graphs to distinguish the relevant items.
  • All sections must be clearly titled and sequentially numbered. For any tables and figures presented in the coursework, you should include necessary axis definitions and legends. Apply appropriate formatting for the tables and figures. Numbers in the text, tables and figures should have a reasonable number of decimal points in order to allow an accurate representation and comparisons (usually between 2 and 4 decimal points). For more details on successful presentation see: https://portal.uea.ac.uk/student-support-service/l…
  • Provide contents list in the beginning of the coursework (we do not require you to write an executive summary or an abstract). Add page numbers on all pages. Include a reference list.
  • In each section, you should follow the instructions to carry out calculation and/or discussion tasks. You should also include details about the data you used and the formulas you applied for your computations. However, try to be brief and clear in your answers.
  • Any questions related to the coursework should be submitted to the “Coursework Q&A Forum” within the “Coursework Information” Section on the Blackboard Site of the module. The link to this forum is within the list on the left. To ask a question, click on “Create Thread” and post your question. You should also click on “Subscribe” to receive an email when a new question is posted. You should visit the forum regularly.

Word Length: 4,000 words

The coursework, includes all of the five sections, should not exceed 4,000 words in total apart from the contents list, references and appendices.

Penalties for exceeding the word limit

Less than 10% over word limit No Penalty
10% or more over the word limit Deduction of 10 marks off original mark
Failure to provide an electronic copy when requested Mark capped to the pass mark
Intentional misrepresentation of the word count on the coversheet Mark capped to the pass mark
NOTE:

1. When the original mark is within 10 marks of the pass mark, the penalty will be capped at the pass mark

2. Original marks below the pass mark will not be penalised

Source: https://portal.uea.ac.uk/documents/6207125/7465906/Section+3+Submission+of+Work+for+Assessment+-+Taught+Programmes.pdf

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