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

Copper Suppliers, Inc. (CS), is a distributor of commercial grade copper. CS purchases copper directly from copper mines and then after refining it, sells the refined copper to in

Answer both parts in this task. Part (i) is worth a maximum of 10 Marks, while part (ii) is worth a maximum of 5 Marks. (i) Minnie owes Micky Mouse $500 and hands him a cheque p

RECEIVERSHIPS: APPOINTMENT OF RECEIVER If a company defaults in payment of principal or interest, or otherwise defaults in observing the conditions contained in debentures issu

Pooling of Interest - Used to account for acquisition of another company when acquiring company exchanges its voting COMMON STOCK for voting common stock of the attained company wh

provide for depreciation at 10%p.a at cost for equipment and 15% at book value for vehicles

A project requires a net investment of $450,000. It has a profitability index of 1.25 based on the firm's 12 percent cost of capital. Determine the net present value of the project

How do I figure fair value of assets..2 year estimated useful life and indefinite life recognized by purchased company

Company A subsequently sells 60% of the voting interest in Company S for $900,000. The fair value of Company A's retained interest of 10% in the voting stock in Company S is $120,0

ACCUMULATION ACCOUNTS FOR MINORS   (a) Income accumulations : When property is left in trust for minors, the income earned for the period will be divided equally or according t