Calculate a volatility smile, Financial Accounting

I am taking  finance class. Our books is John C. Hull 2nd edition Risk Management and Financial Institutions.  Our HW  are from this book. I have four questions I need help with.

1)  What difference does it make to the Var calculated in Example if the exponentially weighted moving average model is used to assign weights to scenarios as described ?

Example

Suppose that, in the example in, five stressed scenarios are considered. They lead to losses($000s) of 235, 300, 450, 750, and 850. The subjective probabilities assigned to the scenarios are 0.5%, 0.2%, 0.2%, .05% and.05% respectively. The total probability of the stressed scenarios is, therefore, 1%, This means that the probability assigned to the scenarios generated by historical simulation if 99%, Assuming the equal weighting is used, each historical simulation scenario is assigned a probability of .99/500 =.00198. The probabilities assigned to scenarios are accumulated from the worst scenario to the best. The Var level when the confidence level is 99% is the first loss for which the cumulative probability is greater than.01. in the our example this is $300,000

The historical Simulation approach

 On September 25,2008 a portfolio worth $10 million consisting of investments in four stock indices: DJIA, FTSE 100, CAC 40 and NIKKEI 225. The value of the investment in each index o September 25, 2008 is shown in Table 12.1.  An excel spreadsheet containing 501  days of historical data on the closing prices of the four indices and a complete set of Var.

Table

Investment portfolio used for VaR Calculations.

Index                                       Portfolio Value ($000s)

DJIA                                          $4,000

FTSE 100                                  $3,000

CAC 40                                     $1,000

Nikkei 225                                  $2,000

Total                                          $10,000

Table

Scenarios generated for September 26, 2008

Scenario Number   DJIA       FTSE100   CAC 40    Nikkei 224   Portfolio Value (000s) Loss ( $000s)

1                          10,977.08  5,187.46     4,236.71  12,252.62    10,021.502                   -21.502

2                          10,925.97   5,234.87    4,275.48   12,155.54     10,023.327                  -23.327

3                           11,070.01  5,164.10     4,186.01   11,986.84    9,985,478                    14.522                             

499                       10,831.43  5,057.36   4,117.75   12,030.80         9828.450                   171.550

500                        11,222.53  5,300.42  4,342.14     11,899.00       10,141.826               -141.826

2) Discuss whether hedge funds are good or bad for the liquidity of markets.

3) Suppose that a financial institution uses an imprecise model for pricing and hedging a particular  type of structured product. Discuss how, if at all, it is likely to realize its mistake.

4) A Future prices is currently at $40. The risk-free interest rate is 5%. Some news is expected tomorrow that will cause the volatility over the next three months to be either 10% or 30%. There is a 60% chance of the first outcome and a 40% chance of the second outcome. Use the derivaGem Software to calculate a volatility smile for three-month options.

Posted Date: 2/21/2013 4:44:23 AM | Location : United States







Related Discussions:- Calculate a volatility smile, Assignment Help, Ask Question on Calculate a volatility smile, Get Answer, Expert's Help, Calculate a volatility smile Discussions

Write discussion on Calculate a volatility smile
Your posts are moderated
Related Questions
Creditors' voluntary winding up    If no declaration of solvency is filed the winding up must take place under the control of the creditors. 1. Meeting of creditors : Th

the salaries paid in 2004 is rs. 500000 salaries outstanding is rs.20000 salaries paid in advance for 2004 is rs 30000 what is the actual salary expenditure for 2004?

Discuss the advantages and disadvantages of different types of financing: 1. Issuing bonds 2. Borrowing from Bank 3. Equity financing

Tally & Co. incurred a pretax operating loss of $100,000 in its first year of operations for both financial reporting and income tax purposes. However, it expects to be profitable

Question 1 a. Contractual liability may be discharged in certain circumstances. Discuss. b. "An aggrieved party in a breach of contract is entitled to claim for damages"

1. Select a publicly traded company (preferably manufacturing oriented; do not use a financial services company such as a bank or a bank holding company) and obtain a copy of their

Assume you hold a diversified portfolio having of a $7,500 investment in every of 20 different common stocks. The portfolio's beta is 2.15. Now, assume you sell one of the stocks w

Effect of Winding-up Order The consequences of a winding-up order are: 1) Any disposition of the company's property and any transfer of shares is void, unless the court otherwis

This is partly taken from a court case where one of my colleagues was a witness. Suppose that an employee is terminated without cause and that she sues the company for compensation

The management of Gimenez Corporation is investigating an investment in equipment that would have a useful life of 7 years. The company uses a discount rate of 17% in its capital b