EFB344 Assignment - Part A (Group Component) Due: Thursday25May 2017 at 11:59pm Weight: 30% of the overall unit (25% for the group work, 5% for the peer evaluation). Group size: 2-3 people (preferably 3). Overview The task you are given is to estimate the market risk for a hypothetical holding of 10,000 Qantas shares (QAN.ax) and 10,000 Fairfax Media shares (FXJ.ax), held on January 3, 2017 (you are working out the risk position assuming that you own these shares before the open of trading that day). You will do this by estimating the Value-at-Risk for the stock portfolio using historical data. You will then analyse two hedging strategies using derivatives that will alter the risk of holding these shares. Description You will be asked to calculate the following; - 10 day VaR for the portfolio of shares at a confidence level of 99%. Note: This risk estimate applies to thenext10 trading days from January3, 2017 until January 16, 2017 (i.e. – it should be a forecast of risk). Based on what you have learnt from EFB344, you realized that you have several options for how to compute this risk measure. You are considering using a VaR based on a) the normal distribution using a 252 day rolling window, b) the normal distribution using the EWMA, or c) historical simulation based on a window of 252 days. To aid in the decision of which to use, you are going to consider the recent historical performance of the three models in calculating 1 day VaR at the confidence level of 99%. You will do so by first examining the frequency of instances when the VaR was exceeded by the observed return using the last five years of data (e.g. – from 3/01/2012 to 30/12/2016). You will then evaluate the appropriateness of these frequencies over time relative to the Basel traffic light levels discussed in lectures. Based on this performance, and any other factors you want to discuss, select the best model and report the required VaR(10, 99%) for January3, 2016. Next, you will look at the possibility of hedging your downside risk over the subsequentthree months using a portfolio of American put options written on Qantas shares and Fairfax shares that expire in exactly three months. The current stock price for each is to be taken as the closing price on 30/12/2016. Your portfolio consists of 10,000 shares of each stock. Assume that the risk-free rate is currently 2% p.a. continuously compounding. The annual variance of each stock can be estimated from historical data using whichever method seems most effective from the VaR analysis above (i.e. – Rolling window vs EWMA). a. Noting that each put option covers 100 shares, determine how many Qantas put options and Fairfax put options you would need to buy to hedge your downside risk. Next, determine the appropriate price for each of these put options if they are at-the-money. Use a six-step binomial tree for this task. b. Repeat the repricing of all the options if the strike price is 10% below the current market price for each share. c. For each of the hedges above, plot a profit diagram that shows the profit from the stock holding, option holding and the combined portfolio (stocks and options) as a function of the share price at maturity (assume that you didn’t exercise the options early and you were able to buy them at the price from part a and part b). Presenting your results - You will then write a brief report of no more than twelve pages including graphs that present your results. A rough outline of what your report could include is o Present the final VaR(10, 99%) for January 3 2017 based on your preferred model. You must also include some explanation of how these final estimates should be interpreted (what does this VaR number mean). o A brief description of the final/preferred VaR model you used. This includes the length of any subsamples of data or selection of any fixed parameters. o Presentation of the main results in the back-testing study. The results should be accompanied with an evaluation of the relative performance of the various models and a clear justification of which model is superior.With this should be a brief description of data (start/end dates, number of observations and details of where you got the data, what the data was (e.g. – closing prices?), how the data was cleaned (e.g. - non-trading days) and how you calculated returns. o A section on the option hedging strategies. Present the profit diagrams representing each hedge. Very briefly discuss the advantages and disadvantages of each hedge. Things to consider might be what risk is being removed and what risk remains, along with the cost of implementing each hedge. - You will also be asked to submit the excel file in which you conducted your analysis. It should be formatted in a reasonably clear way, so that someone who was given the same job after you would be able to understand and replicate what you had done. o I would ask that you use multiple worksheet with the excel file. The first should include the raw data (with dates) as given to you by your source. All working and final results can be compiled on subsequent worksheets. Details of Submission - Submit the report section of your assignment through the assignment portal that is available on the EFB344 Risk Management and Derivatives Blackboard site. Please include your group number (obtained from the Blackboard sign-up) and all three surnames in the file name of your document. Note that the portal will close after the due date and that any assignments that have been granted official extensions must be emailed to Steve Thiele ([email protected]). - Submit the Excel section of your assignment through the separate assignment portal that is available on the EFB344 Risk Management and Derivatives Blackboard site. Please include your group number and all three surnames in the file name of your document. - Also note QUT’s late assignment policy: Late Assignment + No Extension = 0% Additional Notes and Instructions - You will need to source the data yourself. I recommend using Yahoo Finance as was outlined in lecture 2. - For the backtest, you will start with the five years of data specified above when you begin your analysis. This is does not mean that you will have five years of VaR numbers and exceedances to compare (you will have less than this). That is ok, you only need to use the data specified. - Your excel spreadsheet must contain the formulas that you have used for all calculates (i.e. – don’t paste the values of the main calculations). If you have any questions about any of this, please ask them!!!! Criteria and Standards Sheet for Assignment Part A (30 marks) Marking Criteria High Distinction Distinction Credit Pass Fail Mark KS (1.1): Demonstrate and apply integrated discipline (including technical) knowledge Subject Knowledge Demonstrates comprehensive understanding of relevant finance and risk management concepts and techniques. Demonstrates a developed understanding of relevant finance and risk management concepts and techniques. Demonstrates a developed understanding of relevant finance and risk management concepts and techniques but with a few errors. Demonstrates an adequate understanding of relevant finance and risk management concepts and techniques. Insufficient or inaccurate understanding of relevant finance and risk management concepts and techniques. /14 KS (1.2): Apply technical and technological skills appropriate and effective for real world business contexts Excel Use and Formatting Document prepared and formatted according to standards required by the subject. Document generally prepared and formatted according to standards required by the subject, but with a small number of minor errors Document generally prepared and formatted according to standards required by the subject, but contains some errors Frequent errors, but displays an ability to prepare and format the document according to standards required by the subject. Fails to format the document to an appropriate standard required by the subject / 7 HO (2.2): Exercise independent judgement and initiative in adapting and applying knowledge and skills for effective problem solving Critical Analysis Provides a clear and well-reasoned justification for the choice of superior risk management model that fully considers the empirical findings. Provides a strong justification for the choice of superior risk management model that is supported by the empirical findings. Provides a solid justification for the choice of superior risk management model which is generally consistent with the empirical findings. Provides only weak justification for the choice of superior risk management model which barely takes account of the empirical findings. Fails to provide a justification for the choice of superior risk management model and/or the arguments are at odds with the empirical findings. /4 TS (4.2): Apply teamwork knowledge and skills for effective collaboration Work effectively in a team on a finance project Students will assess their team peers on how effectively they performed in the team and on their contribution to the team product via an online survey. Each student will assess every member of their own team and themselves. Students’ score out of 5 marks on this criterion will reflect the average of the ratings received from their peers and their own rating. /5 Overall Grade: HD, D, C, P, F Overall Mark: ________ Comments:An overall mark is awarded to the group, but can be adjusted for individuals at the discretion of the unit coordinator.