Reference no: EM132999174
a) Suppose you were in the financial treasury of a corporation at the start of the COVID19 period, a period of high market uncertainty.
Required: If you were seeking to estimate a VaR model during this time, how would you do it? In your answer, consider any adjustments you would make to the VaR model or its inputs. Use dot points where necessary. Use dot points where necessary.
b) A financial institution has a liability of $150,000 due in exactly 15 month's time. Suppose the firm wishes to manage the interest rate risk of this liability (ie. immunise) using the following two bonds:
- a 12-month zero coupon paying bond with a $75,000 face value (yield of 2% p.a.) with a duration of 12 months, and
- a two-year $75,000 face value, 2% coupon bond (yield of 2% p.a.) with a duration of 1.98 years.
Assume both bonds pay annual coupons and that you can invest in fractions of bonds.
Required: Show that the value of the bond portfolio at the duration date (ie. in 15 month's time) will be sufficient to meet the liability whether interest rates EITHER (i) remain unchanged at 2% p.a., or (ii) increase to 4% p.a. Show all working. Briefly explain your answer.