1. Given the risk report below, comment on the risks determined and give suggest
ID: 2807430 • Letter: 1
Question
1. Given the risk report below, comment on the risks determined and give suggestions to the investor based on the results. Market risk Residual risk Portfolio VaR analysis Benefit Total risk All numbers in USD 000s) Aggregate Ponfolio Diversification Benefit Long DAJ Call Short DAX Call Long DAJ Callable Bond Short 5-yr Euro Swap Long option on WTI future IR FXEquity Cmdty. Specific Spread 0 123 425 -266 336 123 19 94 400 12 72 295 -198-5-240 -26 27120- 310 50-220 25 I14 20 234 105 3834 21 741 1201 16 95 100 12 12 123Explanation / Answer
Description of risks:
1. Market risk: the risk which is often termed as systematic risk that means the risks associated in the market within which the investor operates and will affect all the market participants at certain level. This risk can't be eliminated by diversification although it can be hedged.
Residual risk: After systematic or market risk there is unsystematic risk which can be done away with diversification. But when you have tried all the methods to eliminate risk the element of risk which still exists is residual or inherent risk.
3. Diversification benefits are when the managers try to eliminate risk by combining different stocks or securities in a portfolio which have opposite or zero correlation.
From the data set we can see that the commodity have the highest market risk. Equity doesn't have any market risk. With highest specific residual risk. When diversification benefits are availed the total risk comes to 425.
Diversification benefits are lowest at commodity. And highest at equity. Therefore the investor should allocate more funds to equity and provide lesser weight to commodity.
The market risk on equity is 0 because the long DAJ call has 120 market risk and the short DAJ call as well. Therefore the total equity systematic risk comes to 0.
Long DAJ callable bond has the highest systematic risk on IR because they are more volatile to interest rate fluctuations.
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