Reference no: EM133882672

Derivatives and Risk Management

Assessment - Risk Management Report

Assessment Task
This is an individual task. In this assessment, students are required to form one equity portfolio, evaluate their risks and provide solutions to manage the risk. The goal of this individual assignment is to gain a better understanding of the portfolio investment (in the US stock market) and risk management process.

Below are the tasks:
to build one equity investment portfolio and justify stock selection
to hold the portfolio from and observe its value changes
to identify the portfolio risk by reporting portfolio's VaR
to provide suggestions for managing the risk
to communicate your investment and risk management process using a professional report

Portfolio Creation
Please follow the following steps to build one portfolio.
Create an account (with your real first & surname)
Create a watchlist of one Portfolio based on the close price as of Monday, 12 May 2025
Note: The specified date here is used to start the observation period of your portfolios, not the date on which you must perform the task. For example, you can create portfolios either on Monday, 12 May 2025, or on dates such as 23 May or 1 June 2025, but you will still observe the price change between the sample period Monday, 12 May 2025 to Friday, 23 May 2025. As an illustration, this is the link to the historical daily prices of the AMZN stock.

This watchlist of Portfolio ($1 million) consists of Four stocks from the S&P500
Choose any Three stocks from Table 1 plus Tesla Inc. (TSLA).
For Tesla stock, the number of Tesla shares must equal "the last three digits of your student number" if they are larger than 400 or "the first three digits of your student number".
For exapme: if your student number is S350999, you would hold 999 shares of TSLA; if your student number is S350200, you would hold 350 shares of TSLA in your portfolio.
Determine the weights and shares for the rest of the stocks you chose in step a.
You have USD 1 million for this Portfolio.
Note: Since the shares can't be bought in a fraction, a tiny variation from the specified budget is acceptable. You can choose to hold some Cash if you believe the investment opportunity is not good enough, but you will need to justify this decision in your report. The total $1 million investment you have is based on the share prices on Monday, 12 May 2025.
Take screenshots of your portfolio and the necessary information in all sections. Make sure you attach them in the Appendix of your submitted report.
Suppose this is a Buy-and-Hold strategy, therefore, do not change your portfolio setting during your holding period Monday, 12 May 2025 to Friday, 23 May 2025.

Questions and Marking Guide: Your report must include the following sections:
Trading philosophy:
Give an overview of your philosophy to form the portfolio. You should identify yourself as a value or growth investor or a mixture of both. Provide brief definitions for value/growth investing. Get affordable and professional assignment help now!

Portfolio construction:
Present your initial portfolio, including information on why you have invested in the stocks in your initial portfolio (three stock selection for Portfolio).
The overall market and macroeconomic condition
Industry consideration and/or diversification, specific stock's strengths/positive prospects

Risk identification:
In this part, you should discuss the risk profile of your portfolio. On Monday, 12 May 2025, calculate the VaR of your Portfolio using 2-year daily historical stock price between 11 May 2023 (exclusive) and 12 May 2025 (exclusive). The discussion should include the following points and show key steps of workings:
Calculation and discussion of the one-day 95% Value at Risk of each stock in your portfolio using historical simulation approach. That means, if you have four stocks in total, you need VaR for each.
Calculation and discussion of the 10-day 99% Value at Risk of your portfolio using a historical simulation approach.
Calculation and discussion of the 10-day 99% Value at Risk of your portfolio using model- building approach.
Discussion of the performance of VaR in (b) and (c), by comparing your calculated VaR results and the portfolios' actual 10-day returns (Monday, 12 May 2025 to Friday, 23 May 2025).
Calculation and discussion of the one-day 95% Expected Shortfall (CVaR) of your portfolio using a historical simulation approach.
Note: VaR template can be found in Week 11's material on Canvas. You can download
historical stock prices from MarketWatch as a CSV file, but it limits the maximum data to one year at a time, so you'll need to download multiple times for longer periods. You're also welcome to use Yahoo Finance to obtain historical data but be aware that it will only appear as a screenshot, not as a CSV download, without a Gold subscription.

Hedging using Options:
Suppose you hold the portfolio until the submission day. On any day between Monday, 12 May 2025 and the submission date - 16 June 2025, how will you use the option contract to hedge one of your three selected stocks in your Portfolio. You can choose any stock from the three stocks you selected for the Portfolio. (Please take the screenshot of option quote and spot price as of the same day and attach them in the Appendix of your submitted report).
Assume you decide to use the protective put strategy to hedge the price risk. Explain which option is used (i.e., specify whether it is a call or put, when the expiration date is, appropriate strike price, whether you should go long or short, number of contracts, etc.). Provide justification for your decision. (5 marks)
Note: Option price per share is limited to within 1.5% of the stock's market price and not included in the initial $1 million budget.
Discuss when you will exercise your option and its potential payoff. Support your explanation with a payoff diagram or table.
To further manage your portfolio risk, you decide to explore combining the protective put with a covered call, where you write a call option on the same stock you are hedging. Describe how combining your protective put with a covered call creates a more complete hedge (i.e., a collar). In your answer: Specify the strike price and expiry of the call option you would sell and justify your choice. Explain how this addition changes the overall payoff of your position. Compare the trade-off between the reduced cost of hedging and the capped upside. Support your explanation with a payoff diagram or table.

Hedging costs with Swaps:
As an Australian-based investor, you want to borrow 1 million U.S. dollars at a fixed interest rate to match your investment cash flows. To achieve this, you enter into a two-year currency swap agreement with Mr. Joey Tribbiani, who wishes to borrow Australian dollars at a floating interest rate. The amounts required by both parties are roughly the same at the current exchange rate. You and Mr. Joey Tribbiani have been quoted the following interest rates, which have been adjusted for the impact of taxes:

Design a swap that will net a bank (Bank A), acting as an intermediary, 20 basis points per annum. Unlike a swap equally attractive to both parties, this task requires you to design a swap that allocates 40% of the advantage (i.e., gain) to you and 60% of the advantage (i.e., gain) to Mr. Joey Tribbiani. Determine the rates of interest that you and Mr. Joey Tribbiani will end up paying. Provide an explanation, list your calculation process, and use a diagram to illustrate the swap structure.

The professionalism of the report. (e.g., Usage of professional Figures and Tables, with numbering and captions.)