Swiss Finance InstituteBank Directo

Swiss Finance Institute

Bank Directors' Training II
2015-2017

Module 4:
Introduction to Risk Management

November 2015



Group Assignments

1) Risk Management in General
2) Risk and Return
3) Fixed Income and Interest Rate Risk Management
4) Risk Management with Forwards and Futures
5) Risk Management with Options
6) Risk Management and Enterprise Risk Management
7) Banking Risks


© Professor Alfred Mettler
Georgia State University
J. Mack Robinson College of Business
Department of Finance
35 Broad Street
Atlanta, GA 30303
USA

Phone: (++1) 404 413 7327
E-mail: mettler@gsu.edu


1) Risk Management in General

1. How would you characterize the following events: Risk or Uncertainty? Why?

a) The S&P 500 loses 3% value in one day
b) The price for Copper goes down by 20% in two months
c) A bank has to write off a loan
d) A hacker steals customer data of a bank
e) An earthquake shuts down the power in a city







2. How would you characterize the top ten global risks of the WEF study as shown in the handouts "Risk Management Overview": Risk or Uncertainty?








3. The Volkswagen case which became public in September 2015 showed that VW tried to circumvent U.S. emission regulations by manipulating sophisticated software in its Diesel cars. Where would this type of risk be on a risk map?

2) Risk and Return

1. Following are some risk and return data for stock A, stock B, and the market during the last three years:

Stock A Stock B Market
Return 2012 +40% -10% +10%
Return 2013 +5% 0% -5%
Return 2014 -30% 5% -20%

Standard devia-tion
of returns 2012 30% 12% 15%
Standard devia-tion
of returns 2013 25% 8% 10%
Standard devia-tion
of returns 2014 35% 10% 20%

Discuss the following questions:

a) On an individual basis, which stock is the riskiest?
b) What can be said about the correlation between Stock A and the Market?
c) What can be said about the correlation between Stock B and the Market?
d) What can be said about the correlation between Stock A and Stock B?
e) What can be said about the Betas of Stock A and Stock B?





2. Which of the following statement is correct?
a. A well diversified portfolio diversifies essentially all market risk of a stock
b. A well diversified portfolio diversifies essentially all risk of a stock
c. A well diversified portfolio diversifies essentially all firm-specific risk of a stock
d. A well diversified portfolio guarantees that you will receive at least the risk-free rate
e. A well diversified portfolio maximizes the ratio of firm-specific risk to market risk



3. Consider the following two securities:

Expected Standard
Return Deviation
Stock A 8% 15%
Stock B 12% 25%

The correlation coefficient between Stock A and Stock B is 0.4. Given a 2 security portfolio comprised of 50 percent Stock A and 50 percent Stock B, what can you say about the portfolio return and the portfolio standard deviation?









4. Which of the following statements is true?

a) The CAPM predicts that a stock with a beta of zero will offer a zero expected re-turn
b) An investor has invested $1000 in Treasury bills and $2000 in the market portfo-lio. Therefore the total investment will have a beta of 2.0
c) Investors demand higher rates of return on stocks with a higher beta
d) The market risk premium cannot be higher than the risk-free interest rate
e) The required return on the market must be less than the market risk premium






5. Stock A has a beta = 1.4, while Stock B has a beta = 0.7, and the risk-free interest rate is 3%. Which of the following statements is most correct?

a) Stock A’s required return must be double that of Stock B’s
b) An equally weighted portfolio of Stock A and Stock B will have a beta of less than 0.7
c) If market participants become more risk averse, the required return on Stock A will increase more than the required return on Stock B
d) An equally weighted portfolio of Stock A and Stock B will have a beta of more than 1.4
e) Answers a and c are correct


3) Fixed Income and Interest Rate Risk Management


1. Assume interest rates on long-term government and corporate bonds are on average as follows:
Maturity 3 months 5 years 30 years
Treasury ? 4.5% 5.5%
AA-rated corporations 3.5% 5.2% ?
B-rated corporations 4.2%% ? 8.5%

Which of the following statements is most correct:

a) The 3-month Treasury rate is between 3.5% and 4.5%
b) The Treasury yield curve is inverted
c) The 5-year B-rated bond’s interest rate is between 4.2% and 5.2%
d) The 30-year AA-rated bond’s interest rate is between 5.5% and 8.5%
e) None of the above answers is correct


2. What can be said about the duration of a zerobond (i.e, a bond that does not pay any interest until its maturity)?


3. You know the following duration values:
a) Bond with 10 years maturity, 5% coupon, YTM=7%, Duration = 7.9 years
b) Bond with 15 years maturity, 8% coupon, today issued at par,
Duration = 9.2 years
c) Bond with 7 years maturity, 4.5% coupon, YTM=6%, Duration = 6.1 years
What will happen to the price of these bonds if there is an immediate interest rate in-crease of +0.5% for all maturities ( = flat yield curve)?


4. Ideally a bond portfolio should have a short duration at the end of a low-interest phase (i.e., expecting higher interest rates in the future), and a long duration if lower interest rates are expected in the future.
a) True
b) False


5. A bond portfolio consists of 3 bonds:
Bond A: Market value 6 millions, duration = 8
Bond B: Market value 4 millions, duration = 5
Bond C: Market value 10 millions, duration = 4
What can be said about the duration of the portfolio?





6. You know the following information about the balance sheet of Finex AG:

There are four types of assets (A1, A2, A3, A4) and three types of liabilities (L1, L2, L3) as follows:
Type A1 A2 A3 A4 L1 L2 L3
Market value 20 30 50 100 30 60 90
Duration (years) 4 5 6 8 3 4.5 6

Today’s interest rates are at 6 % (flat yield curve). You expect an interest rate in-crease to 7%.

a) Visualize the balance sheet
b) Calculate the duration of assets and liabilities?
c) Calculate the change in the market value of equity, caused by a 1% increase in interest rates
d) How could the duration gap be reduced or eliminated (conceptual answer)?










4) Risk Management with Forwards and Futures


1) Which of the following statements is false:
a) At expiration the basis of a financial futures should be Zero
b) A short futures position entails an obligation to deliver, and a long futures posi-tion entails an obligation to accept delivery and pay for it
c) The huge majority of financial futures are „cash settled“
d) The initial margin is an expense that has to be paid at the opening of a futures position









2) At the beginning of August the S&P 500 Dec Future is at 1,900. An investor sells five S&P 500 Dec Futures at this price. One month later he closes the position at 1,800. What is the profit/loss?








3) You have sold 10 Treasury Bond Future contracts at 152-16/32. If you closed the position two weeks later at 154-0/32, you would have a capital gain/loss of
a) gain of $1,500,000
b) loss of $1,500,000
c) gain of $15,000
d) loss of $15,000
e) gain of $1500
f) loss of $1500
g) gain of $150
h) loss of $150




4) If the yield curve is flat then the S+P 500 Futures should theoretically equal the S+P 500 spot price, since financing costs and return on underlying neutralize each other.
(a) True
(b) False






5) If you are short on a futures contract and the price of the underlying goes down, in which direction can you expect the balance of your margin account to change:
a) Higher Balance
b) Unchanged Balance
c) Lower Balance







6) At the beginning of August a portfolio manager manages a stock portfolio which is worth 40 million $ and has a Beta of 1.2 against the S&P 500 Futures. How many S&P 500 Dec Future contracts (at a level of 1,900) does the portfolio manager have to buy/sell in order to be fully hedged against a decline in stock prices? Calculate the number of contracts and indicate whether they have to be bought or sold.

5) Risk Management with Options

1) Identify the following P/L-diagrams (i.e. payoff diagrams with the share price being displayed on the x-axis). Write the corresponding letter in the table below:
Short Call Long Call Short Put Short Stock Long Put



A B C D


F G H I




2) Which of the following statements is incorrect:
a) The option premium is an immediate expense for the buyer of a put option
b) A European Option can be exercised only at expiration
c) The time value of an option can be higher than, equal to, or lower than the in-trinsic value of the same option
d) An option value can be negative or positive
e) The seller of a put receives the option premium

3) Which of the following statements is correct
a) The time value of an option will always be greater than the option value (=option price) of the same option
b) The intrinsic value of an option will always be greater than the time value of the same option
c) The intrinsic value of an option can never be greater than the time value of the same option
d) For an at-the-money option the time value will be zero
e) At expiration of an option, its time value will be zero (or very close to zero)

4) A call option (exercise price = $100, actual value of the underlying = $90) was just sold for $8. This call option is …………… and the time value of this call option is ………
a) in-the-money, $2
b) out-of-the-money, $2
c) in-the-money, $8
d) out-of-the-money, $8
e) in-the-money, $10
f) out-of-the-money, $10

5) For an out-of-the-money option, the intrinsic value is zero and therefore the time value equals the option value
a) true
b) false


6) Which of the following statements is incorrect
a) The longer the time to expiration, the higher the value of a put option (every-thing else being unchanged)
b) The longer the time to expiration, the hi