Global Fund Risk Assessment & Hedging Strategy

  • Estado: Closed
  • Premio: $30
  • Propuestas recibidas: 19
  • Ganador: Zakwan555

Resumen del concurso

You work as an economist in the economics team of a US Fund that has global index investments in Australia, Brazil, Europe, UK, Japan and South Africa.
The Fund would like to measure its exposures including foreign exchange exposures over the next year and if these exposures are going beyond certain limits, the fund would also like to implement a hedging program. This helps the fund to reduce its risks to acceptable levels so its returns and thus its value is not affected.
Suppose that the fund is marked to market at $100 million dollars distributed as follows: $20 million invested in Australia (Australian Dollars) in the S&P/ASX 200, $15 million in Brazil (Brazilian Riyals) in the IBOVESPA index, $20 million in Germany (EUROs) in the DAX index, $15 million in the UK (British Pounds) in the FTSE100 index, $20 million in Japan (Japanese Yen) in the TOPIX index, and finally $10 million in South Africa (South African Rand) in the FTSE/JSE Africa All Shares Index.
To measure losses that can be realized in a bad year, the fund would like to compute value at risk at the 5% and 1% levels. In particular, the economics team of the company would like to compute VARs at 5% and 1% respectively. If the maximum loss 99% of the times is than $20 million, the fund will not hedge fund exposures using index futures, options and/or other currency derivatives. Otherwise, it will implement a hedging program that dissipates these potential losses.
Based on experience and evidence, the economics team have decided to assume that fluctuation in equity market returns, and foreign exchange returns are independent. This assumption will also facilitate the computation of total VAR of the fund that emanates from both currency fluctuations and stock market volatility.
Requirements:
1- Collect the following:
a. time series of monthly exchange rate of the dollar against the Australian Dollar (AUD), Brazilian Real (BRL), Euro (EUR), Japanese Yen (JPY), South African Rand (ZAR) and the UK pound (GBP). Collect for the last 10 years.
b. time series of monthly indexes of Australia, Brazil, Germany, Japan, South Africa and the UK. Collect for the last 10 years.


2- From the collected data, compute the returns of the currencies. Compute the variance-covariance matrix for currency returns. Repeat for equity indexes.

3- Assume equity value is not changing. Compute the annual portfolio volatility stemming from currency fluctuations. Compute the portfolio VAR at the 1% level assuming normality. For VAR computation, use the 12-month forward rate to compute the expected returns of a particular currency.


4- Assume currency values are not changing. Compute portfolio volatility stemming from equity fluctuations. Compute the portfolio VAR at the 1% level assuming normality. Assume reasonable annual equity market expected returns of the indexes.

5- Compute the total VAR as the sum of the currency VAR and equity VAR by assuming independence. Comment on the relation between actual VAR and the total VAR computed.

6- Indicate if the company should be hedging. Discuss briefly how the fund may reduce its risks to the required level using derivatives?

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