BWRR 3063 CONFIDENTIAL FINAL EXAMINATION SECOND SEMESTER 2012/2013 SESSION COURSE CODE / NAME : BWRR 3063 / FINANCIAL RISK MANAGEMENT DATE : 20 JUNE 2013 TIME 19:00AM — 11:30AM (2 % HOURS) VENUE : DTSO, KIA, KTB INSTRUCTIONS : This examination paper contains SIX (6) questions in FOUR (4) printed pages excluding the cover page with ONE (1) page of Appendix. 2. Candidates are required to answer ALL questions in the answer booklet provided. Candidates are NOT ALLOWED to take both exam question and examsheet out of the exam hall Candidates are bound by the UUM’s RULES AND PROCEDURES ON ACADEMIC FRAUD. MATRIC NO : (in words ) (in numbers ) IDENTIFICATION CARD NO. : LECTURER : GROUP : l] TABLE NO. : DO NOT OPEN THIS EXAMINATION PAPER UNTIL INSTRUCTED CONFIDENTIAL‘BWRR 3063 FINANCIAL Risk MANAGEMENT ‘MATRIC NO: QUESTION ONE (25 MARKS) Corporate entities believe that the successful operation of any business depends on risk management. In addition, there is evidence in terms of theories that show how value can be created from the adoption and application of risk management and how risk can also destroy corporate value. Most importantly, effectively managing or controlling the factors that cause risk can result in market leadership, increasing a company’s growth and investor confidence, Based on the above statement: a) How you define risk and risk management from finance perspective? (4 marks) ») Explain the THREE (3) main sources of financial risk. (6 marks) ©) What are the types of financial risks? Why financial companies are concerned on these types of risks? (5 marks) 4) Give TWO (2) benefits of managing risk in an organization. (4 marks) ©) Explain the importance of risk management standard, regulation and compliance for companies to effectively managing their risk. (4 marks) f) What are the objectives of Capital Accord (Basel)? (2 marks) QUESTION TWO (15 MARKS) The definition of operational risk by Basel Committee has become an industry standard. It defined operational risk as ‘the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events’. a) Explain the FOUR (4) categories of risks in the above definition and give ONE (1) example for each category. (8 marks) b) What are the TWO (2) types of risks that are excluded in the definition and why they are excluded? (3 marks) ©) What is the effective tool that being widely used by companies in mitigating operational risk? Explain your answer. (4marks)_BWRR 3063 FINANCIAL RISK MANAGEMENT ‘MATRIC NO: QUESTION THREE (10 marks) a) Whatiis the major source of liquidity risk? Explain how the source of risk occurs. (3 marks) b) Unite Corp. has bought some illiquid shares which comprised of 200 shares of LCL Corp. quoted at bid price $40 and offer price $40.50, and 350 shares of Mega Holdings quoted at bid price $ 31 and offer price $ 32. i. What are the proportional bid-offer spreads for both investment instruments? (3 marks) li, If the bid-offer spreads are nommally distributed with the mean $8 and standard deviation $2, what is the cost of unwinding that the investor is 95% confident will not be exceeded? (4 marks) QUESTION FOUR (25 MARKS) In September, a purchasing manager for an oil refinery in China plans to purchase 500 metric tons of crude palm oil (CPO) in 3-months times. He is concemed that CPO would continue to move in upward trends. Therefore, he intends to lock-in the purchase price now. The current CPO price in the spot market is at USD560/metric ton and the futures price for December, is at USD580/metric ton. (1 FUPO contract = 25 metric tons) a) Identify the risk exposures facing the oil refiner. (2 marks) b) What should the purchasing manager do to lock-in the CPO price? (2 marks) ©) How many FUPO contracts does he need in order to be fully hedged? (1 mark) d) Assuming when it is time for the oil refiner to obtain the 500 metric tons of CPO in the physical market in December, the CPO price in the spot market is USD5S0/metric ton ‘and the December FUPO contract price is USD550/metric ton i. What is the profit or loss of the FUPO position when it is closed? (4 marks) Ji, What is the effective price that the oil refiner has paid for the 500 metric tons of cpo? (4.marks) ) Explain how an insurance contract is similar to an option contract. (6 marks) ) Forward and futures are instruments use to hedge market risk. Briefly explain THREE (3) distinguish features of forward and futures, (6 marks)‘BWRp 3063 FINANCIAL RISK MANAGEMENT MATBICNO. QUESTION FIVE (13 MARKS) “Moody's is the first of the big-three credit rating agencies to place the United States’ Aaa rating on a review for a possible downgrade, meaning the agency is close to cutting the country’s rating.” Excerpt from “US ratings on review’, Starbiz, 15 July 2011. a) Whats the role ofa credit rating agency’? (2 marks) b) Briefly explain the major impact ifthe possible downgrade happened (2 marks} ©) The spread between the yield on a 5-year corporate bond and the yield on a similar risk- free bond is 60 basis points. The recovery rate is 40%. Estimate the average default intensity per year over the 5-year period. (2 marks) 4) Below is S&P Average Cumulative Default Rates (%) for AA rated company. Time Horizon (year) Rating | 1 a 3 4 5 6 AKA | 0.60] 0.04) 0.17) 0.90) 0.43) 0.56 AA | 0.04] 009] 0.19] 0.34) 0.48) 0.64 [a__| 008 |"0.23| 0.41] 0.62) 0.84] 1.08 eae [ oar! 071] 1.16) 121] 248) 316 i. What is the probability of AA-rated bond defaulting during the first, second, third and fourth year? (2 marks) ii. What is the unconditional default probability for AA rated company in the third year? (1 mark) ii, What is the probability that AA rated company will survive until the end of second year? (1 mark) iv. What is the default intensity for A rated company in the third year? (1 mark) v. Explain why default probability for AA rated bond increase with time? (2 marks)‘BWR 3063 FINANCIAL RISK MANAGEMENT MATRIC NO: QUESTION SIX (12 MARKS) a) Suppose the change in the value of a portfolio over a 30-day time horizon is normal with a mean of zero, standard deviation of $10 milion. i. Calculate 30-day 97.5% VaR. (3 marks) ji, Based on the answer (i) above, calculate 5-day 97.5% VaR. (4 marks) ji, Based on the answer (i) above, calculate 5-day VaR at 99%. (3 marks) b) You are required to interpret a report to 2 non technical corporate executive. The report stated one-month 99% VaR is 20% of the size of the asset under management. You currently have RMS00 milion worth of asset under management. How do you interpret the report? (2 marks) END OF QUESTIONS