As part of this project you will need to answer all the questions shown below. You should assume that your analysis is conducted on 1st December 2017. All the data you need to collect will have to be consistent with such date. State the assumptions, if any, you need to make to carry out your calculations and explain why, in your opinion, they are sensible. 1. [20% weight] Calculation of the risk of a sovereign loan portfolio. a. With the CreditMetrics model compute 95%, 99% and 99.9% absolute VaR and ES for the portfolio of sovereign loans assigned to your group (see the Appendix). Use a time horizon of 1 year, 10,000 Monte Carlo simulations and a 30% asset correlation. [Note: Absolute VaR in CreditMetrics is computed as V0-V* where V0 is the value of the portfolio as of 1st December 2017 and V* is the simulated 1-year forward portfolio values at the 5%, 1% and 0.1% percentiles, respectively. Absolute expected shortfall is computed as V0-V** where V** is the average of the portfolio values below V*. ] b. Explain why you think that your results are plausible. Portfolios are composed of exposures to France, Germany, Italy and Spain. To implement CreditMetrics you will need the following information: a. Zero coupon government spot yield curves which can be downloaded from the Bloomberg terminal. If you are new to Bloomberg you can find some tips on how to use it at this link. There are also plenty of tutorials available in YouTube (just search for the keywords: Bloomberg tutorial for beginners). Type in the codes below for the countries that are relevant for your portfolio and select the link to the yield curve that will appear on the terminal. Then select “HP” to get the historical price table. Adjust the top drop down menu to select “from” and “to” dates, yield maturity range to cover the maturities of the assets in your portfolio, and “Mid trade” under “Market”. The Bloomberg codes for the yield curves are: i. France: Bloomberg code YCCF0916 ii. Germany: Bloomberg code YCCF0913 iii. Italy: Bloomberg code YCCF0906 iv. Spain: Bloomberg code YCCF0903 b. Country ratings should be sourced via the Moody’s website. Simply select “look up a rating” from the “Research and Ratings” tab. You will need to register with Moody’s to have access to the rating information. Registration is free. c. Sovereign default rates and recovery rates can be obtained from the document “Sovereign Default and Recovery Rates, 1983-2016” which can be downloaded from the Moody’s website. 2. [20% weight] Stress testing: Compute the 95%, 99% and 99.9% absolute VaR and ES for your portfolio under the following stress scenarios. Consider the effect of each scenario separately and then all combined.
[Note: The stress scenarios should only be applied to the calculation of V* and V** only. V0 should be computed as before, i.e. with data referring to 1st December 2017.] Scenarios: a. Assume all the sovereigns represented in your portfolio are downgraded to Ba. b. Assume the highest sovereign yields observed in the period 1/1/2010- 31/12/2012. c. Assume asset correlation goes to 70%. d. Explain why you think that your results in all the above points are plausible. 3. [20% weight] Review the ESRB report on the regulatory treatment of sovereign exposures and answer the following questions: a. Why can banks’ sovereign debt exposures be a problem? [max 200 words] b. What are the issues with the current regulatory capital treatment of sovereign debt exposures in banks? [max 200 words] c. Compute the regulatory capital charges under the standardised approach and the IRB approach for the sovereign debt portfolio assigned to you. How do they compare with the VaRs you have computed in questions 1 and 2? What inference can you make from such comparison? [max 200 words] d. Do your results support the concerns in the above report? [max 200 words] 4. [40% weight] Essay (max 1,500 words): Watch the FT video “How to spot a financial crisis before it spots you” and answer the following questions: i. What are the main factors that may cause a serious financial crisis in the near future? ii. What steps should investors, financial institutions, regulators and governments take to avoid future financial crises? iii. What behavioural changes are necessary to help prevent future crises? How can these behavioural changes be implemented? In your essay address the above points in separate sections. Draw information from academic papers, (e.g. from Science Direct) industry papers (e.g. from regulators and practitioners) and the financial press. The essay should include an executive summary of no more than 100 words and a full list of references. Also include between 3 to 5 figures or tables in your essay to illustrate the points you are making and follow these stylistic guidelines. Figures and tables can be taken from other published material, in which case the source needs to be acknowledged in the figure/table legend, or built by yourself with data you may have obtained from Bloomberg, Reuters, Datastream or other services. The summary, references and tables and figures should not be included in the word count. If you have queries concerning the project you can contact me via email or in person during my office hours. Please bear in mind that data collection is your responsibility and forms part of the assessment for your project. C. Admin As part of the assessment for this project you will need to submit: 1. An Excel spreadsheet with all your calculations. The spread sheet should be tidy and easy to read. The Excel file should also include all the raw data indicated in the data section below. The data provider and data identifiers (i.e. DataStream or Reuters securities codes) should be reported so that we can verify what you have done. In the spreadsheet you should clearly explain what you are doing. You should label data/results and comment on your calculations. 2. A Word document with a separate answer to all the above questions 1-4. The word document should be self-contained so that the reader will not need to refer back to the Excel file. In other words, all the main results discussed in the Word document should be reported and summarised in it. Each answer should be clearly labelled with the number of the question or sub-question it refers to. By 2pm on Monday 9th April 2018 you should submit, via Blackboard, the two documents above. You can do so by going to the “course documents” of the Management of Risk module. Then select “group project” and upload the files (you can find instructions on how to do this by clicking the “student support” tab and checking the material under “Submitting work online via the Blackboard Assignment tool”). The group number as well as the names of the group members should be clearly indicated on all the documents. Assessment The assessment for this project will be based on the following parameters: o Technical proficiency: quality of analysis, clarity of Excel spreadsheet, calculations and results in the spreadsheet appropriately commented on, clarity and completeness of summary report (i.e. the Word document). o Peer assessment. You will have the opportunity to grade one another’s contribution to the project, which will affect individual project scores as shown in the table below. A peer assessment online form will be made available in due course. Peer assessment criteria The mark awarded for the project will be scaled according to a peer assessment of your contribution to the group. Each member of the group is asked to complete this online form for each of their colleagues. The form includes the following questions: Did X act compassionately* towards the other members of the group? Yes/No Did X attend regularly your meetings and was on time? Yes/No Did X contribute ideas to the group? Yes/No Did X produce the work they were assigned and give it to the group on time? Yes/No Did X read and comment on the draft report? Yes/No *Compassion score. You should base your compassion score for a group member on the extent to which that teammate is kind and helpful towards other group members. Recent research shows that compassion is a crucial feature of successful teams. This video explains Google’s philosophy on compassion, which you may find interesting. Every “yes” answer translates to a score of 1, while every “no” results in a mark of 0 for that criterion. I will then calculate an average for each team member and use it to award a personal score for the project. The table below assumes that the mark for the project is 60%.
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