Financial Risk Management - Major Project - Group Task
Limit your response to 10 pages (including appendix)
You are a junior analyst for GAMBLE - a large, high-risk, high leverage hedge fund that specialises in Australian multi-asset strategies.
Following on from the successful completion of previous tasks assigned to you, the portfolio managers have allocated you to a team of junior analysts in charge of monitoring the risks of a leveraged, multiasset portfolio. You are to prepare a report for the risk management committee. The report should cover short to medium term risk (The last day of the financial year in 2017 – the portfolio may need to be sold in FY2017 to effectively manage client’s tax obligations.). Use the closing prices from the 10th May, 2017 and a 95% confidence level.
Each portfolio consists of:
• 2 Australian Bonds - $5,000,000 long position in CBAAU 0 01/20/18 Corp and TLSAU 9 09/15/17 Corp
• €3,400,000 cash position
• 2 Ordinary Shares - $5,000,000 long position in STO and FMG
• 2 Stock Options - A short position in STO AU 06/29/17 C3.66 and FMG AU 06/29/17 C4.9 such that the net change of the combined initial stock and option combination is zero ($5,000,000 worth of protection - delta neutral on the day of valuation)
Furthermore, the portfolio is currently levered 19:1 - i.e. for every $1 of investors funds, $19 is borrowed via various margin loans, repurchase agreements and other financing arrangements. When investors no longer have equity, the portfolio, in accordance with its guidelines, will declare default and liquidate all its assets.
Due to an ongoing concern about the portfolio’s high level of risk you have been asked to consider liquidating one of the assets and investing the proceeds into another asset to reduce the overall risk of the portfolio. You are to propose one such trade and back test your strategy and demonstrate its effectiveness in reducing the VaR of the portfolio. You do not have to use all of your sale proceeds to make the purchase, however, the proportion of cash within your portfolio may not exceed 30%.
You are also concerned that the recent bull market may not adequately describe the extent of potential exposure of your portfolio. Accordingly, you are to conduct a stress test and evaluate the portfolio under a number of extreme but probable states of the world.
Portfolio Risk Report
At the barest minimum, this report should cover:
• Qualitative discussion around the portfolio’s risk characteristics
• Analysis of risk factors faced by the portfolio (You may use Bloomberg to identify the factors)
• Quantification of the overall portfolio market, credit and liquidity risks using methods covered in this course
• A brief description of the hedging security that could be employed to reduce risk exposure • Clear identification of the stress test and scenarios and quantification of the losses
• A brief discussion on how to mitigate the portfolio default risk in the current market - e.g.
increase cash holdings, purchase/sale of another security - and the viability of these strategies
• This assignment is deliberately open ended. Do not panic.
• There is no limit on what methodologies or analytical frameworks may or may not be applied in this assignment. We recommend full reference to all relevant materials covered in the course.
o Additional research is not essential even to get full marks, but we remain flexible if students do want to attempt to go the extra mile.
o Additional research in the form of plagiarism will result in a fail.
• Think carefully before you commence analysis - note that the securities in your portfolio do not operate in a vacuum, but rather within a big picture.
• Clearly state all your assumptions.
• Mechanical application of various techniques, or discussion that patently lacks understanding around the underlying methodology is the fastest and most efficient way to fail this assignment. • Do not dismiss the recommendation of viable risk management strategies as an afterthought. This section separates students who really understand the course and task from those that do not.