DEGREE EXAMINATIONS: MAY/JUNE 2022
SCHOOL OF MANAGEMENT
MN-3507: Risk Management in Banking
SECTION A - Answer ALL Questions
Question 1
Bank of Paz has a trading division that comprises of three business units, namely fixed- income, foreign exchange (FX) and equity trading. As of today, the trading division has the following information to be presented to its management team:
|
|
Business Unit 1
Fixed-income Trading
|
Business Unit 2
FX Trading
|
Business Unit 3
Equity Trading
|
|
Exposure USD
|
1000
|
500
|
300
|
|
Return volatility
|
0.60%
|
1.40%
|
1.80%
|
|
Correlation with BU1
|
1
|
-0.04
|
0.03
|
|
Correlation with BU2
|
-0.04
|
1
|
0.25
|
|
Correlation with BU3
|
0.03
|
0.25
|
1
|
a) Please calculate one-day value-at-risk (VaR) for each unit, if the confidence level is set at 99%. [4 marks]
b) Please numerically prove to its management team which unit is able to achieve the most diversification for the division and explain why. The confidence level remains at 99%. [10 marks]
c) Assume that the management team wants to reduce the VaR for the entire trading division. It, therefore, suggests that Business Unit 1 (i.e. fixed-income trading unit) should increase its exposure to $1200, while other units remain the same. Please prove to the management team whether this target can be achieved or not. The confidence level remains at 99%. [6 marks]
Question 2
Due to heightened political risk and volatile stock market reaction, Bank of Paz considers the possibility of liquidating its entire Business Unit 3 (i.e. equity trading unit).
Assume that all the business units remain unchanged as previous question presents:
|
|
Business Unit 1
Fixed-income Trading
|
Business Unit 2
FX Trading
|
Business Unit 3
Equity Trading
|
|
Exposure USD
|
1000
|
500
|
300
|
|
Return volatility
|
0.60%
|
1.40%
|
1.80%
|
|
Correlation with BU1
|
1
|
-0.04
|
0.03
|
|
Correlation with BU2
|
-0.04
|
1
|
0.25
|
|
Correlation with BU3
|
0.03
|
0.25
|
1
|
Business Unit 3 current only invests in stock Vodafone Group plc.
The mean and standard deviation for the proportional bid-offer spread for this stock are 0.05 and 0.001, respectively.
The spread is normally distributed.
Please calculate the total potential loss from this business unit due to market risk and liquidity risk today, if the confidence level is set at 99%. [5 marks]
SECTION B - Answer THREE Questions
Question 1
With the help of a graph, please explain the framework to estimate the amount of economic capital a bank needs against its credit risk. [25 marks]
Question 2
Under Basel regulation, banks can either use standardised approach or internal ratings- based (IRB) approach to manage their credit risk. Additionally, banks also use value-at-risk (VaR) as a part of their credit risk management. Please examine one situation how the VaR is implemented as a part of credit risk management in banking. [25 marks]
Question 3
Ball (2020) states that the central events of the last global financial crisis were liquidity crises at large financial institutions. Please use at least two examples to discuss whether his claim is correct. [25 marks]
Question 4
Explain the advantages and disadvantages of using duration gap analysis compared to income gap analysis. [25 marks]
Question 5
Basel regulation has evolved to comprise three pillars concerned with minimum capital requirements (Pillar 1),supervisory review (Pillar 2), and market discipline (Pillar 3). Please explain in details what these three pillars are and how they are intended to improve banking stability. [25 marks]