Reference no: EM132245787 , Length: word count:800

Question -

David Viniar, Goldman Sachs' CFO, said during the summer of 2007 that the investment bank had lost 27% of its value since the beginning of the year. He further said, "We were seeing things that were 25-standard deviation moves, several days in a row." The risk management model which Mr. Viniar mentioned was based on normal distribution, which assigns probability of such an event occurring once in 100,000 years. Subsequently, his explanation was criticised as it highlighted the inadequacy of the Goldman Sachs' risk management models rather than the extraordinary conditions on the market.

Discuss Mr. Viniar's statement. Evaluate the main theories behind use of models based on Gaussian (normal) distribution and assess how they might have undervalued market risks and whether and how these models might have contributed towards the credit crunch.

(Minimum 500 words)

Instant Feedback Task -

As an investment banker, you are responsible for a portfolio of assets and you need to calculate various scenarios for its future values. Based on past records as well as current expectations, the portfolio is expected to grow by £1 million, with a standard deviation of £500,000 over the next year. The returns are considered normally distributed.

Calculate the following scenarios:

1) Probability that the portfolio will lose more than £100,000 over the next year.

2) Potential loss to the portfolio equivalent to 3% probability.

3) Probability that the portfolio growth will be positive next year.

4) Probability that the portfolio will gain between £0.5 and £1.5 million.

Task: As an investment banker, you are responsible for a portfolio of assets and you need to calculate various scenarios for its future values. Based on past records as well as current expectations, the portfolio is expected to grow by £1 million, with a standard deviation of £500,000 over the next year. The returns are considered normally distributed.

Calculate the following scenarios:

1) Potential loss to the portfolio equivalent to 4% probability.

2) Probability that the portfolio growth will be higher than £500,000.

3) Probability that the portfolio's return will be under £0.8 or over £2.2 million.