Principles of Banking - N1577
Seminar 7. Systemic and Other Bank Risks
Question 1.
An investor has a leverage limit (assets/equity) of 10 and holds a portfolio of assets worth of $500. In this portfolio, s/he has 100 units of the same security with a price of 5$ each.
a. What are the options available to the investor if price goes up to $5.5 or goes down to $4.5?
b. Ceteris paribus, if the leverage limit was 5, how would that change the behavior of the investor in response to changes in prices?
Question 2.
Suppose that a bank has bought 10 million shares of one company and 50 million ounces of a commodity. The shares are bid $89.5, offer $90.5. The commodity is bid $15, offer $15.1.
a. Calculate the cost of liquidation under normal market conditions.
b. The following assumptions are made:
- The bid-offer spreads are normally distributed.
- The mean and standard deviation of the bid-offer spread for the shares are 1.0 and 2.0,respectively.
- The mean and standard deviation of the bid-offer spread for the commodity are both 0.1.
Calculate the cost of liquidation in stressed market conditions at a 99% confidence level.
Compare the two costs you have calculated.
Question 3.
Suppose that a trader has bought some illiquid shares. In particular, the trader has 100 shares of A, which is bid $50 and offer $60, and 200 shares of B, which is bid $25 offer $35. What are the proportional bid-offer spreads? What is the cost of liquidation under normal economic conditions? If the bid-offer spreads are normally distributed with mean $10 and standard deviation $3, what is the 99% worst-case cost of unwinding the portfolio in the future?
Compare the two costs you have calculated.