COMMUNICATION SKILLS

Communication Skills and Operational Research for Finance, Coursework on Communication Skills



Communication Skills and Operational Research for Finance, Coursework on Communication Skills

Problem

An investment proposal is under consideration of the company's management. Proposal entails investing in a portfolio composed of 100 shares of a stock. Currently one share of this stock sells for £100. It has been already estimated that the annual rate of return of this stock is 10% and its annual volatility is 20%. In order to evaluate the investment proposal, we need to use VAR to assess the stock on the basis of previous 3 month performance. the management has also set the criteria for accepting or rejecting the proposal on the basis of VAR estimations and risk appetite.

Problem

An investment proposal is under consideration of the company's management. Proposal entails investing in a portfolio composed of 100 shares of a stock. Currently one share of this stock sells for £100. It has been already estimated that the annual rate of return of this stock is 10% and its annual volatility is 20%. In order to evaluate the investment proposal, we need to use VAR to assess the stock on the basis of previous 3 month performance. the management has also set the criteria for accepting or rejecting the proposal on the basis of VAR estimations and risk appetite.

Value at Risk

Definition

VaR is a term commonly used to gauge the market risk of a portfolio comprising of financial instruments. It is the amount of losses that should only be exceeded with a prespecified probability over a given time horizon. The use of VaR is no longer limited to financial instruments; it can be a tool for risk management in all areas. To calculate VaR, it is necessary to model the portfolio (and therefore make assumptions). In particular, this means to assign a probability to different possible evolutions of the portfolio. VaR is always conditional modelling of a hypothetical future that necessarily has its limits. The VaR can be used:

For the calculation of economic capital ;

For monitoring market risks, both as risk reporting and as a tool for decision support;

For credit risk,

For regulatory requirements (regulatory reporting and specific requirements).

Value at Risk, in simplest form, measures the possible loss in value of the portfolio or an individual and risky asset for a given confidence interval over a defined period. In our case, the VAR on stock is $ 100 million with 95% confidence level, and time duration is 7 days; there is a only a 5% chance that the price of the stock will witness a fluctuations of more than $ 100 million during the seven days period. In its modified form, value at risk measure is the potential loss in price from “normal market risk” in contrast to all risk. It requires us to make a distinction between market and nonmarket risk as well as between normal and abnormal risk.

To determine the likelihood of the loss for a given confidence level, we need to identify the probability distributions of risks associated with each security on the portfolio, the correlation between these risks and the result of these ...