BAFI1029 Derivatives and Risk Management

Assessment 3 - Individual Risk Management Report (50%)

Report and Excel

Due Date: Week 13 - Friday, 10th October 2025 by 23:59 (Singapore Time)

Assessment Task

This is an individual task. In this assessment, students are required to form one equity portfolio, evaluate  their  risks  and  provide   solutions  to  manage  the  risk.  The  goal  of  this  individual assignment is to gain a better understanding of the portfolio investment (in the US stock market) and risk management process. Below are the tasks:

●    to build one equity investment portfolio and justify stock selection

●    to hold the portfolio from Monday, 1st September 2025 (beginning of Week 8), to Friday 19th September 2025 (end of Week 10) and observe its changes

●    to identify the portfolio risk by reporting portfolio’s VaR

●    to provide suggestions for managing the risk

●    to communicate your investment and risk management process using a professional report

Portfolio Creation

Please follow the following steps to build one portfolio.

1.    Create an account (with your real first & surname) onwww.marketwatch.com

2.    Create a watchlist of one Portfolio based on the close price as of Monday, 1st September 2025

Note: The specified date here is used to start the observation period of your portfolios, not the date on which you must perform the task. For example, you can create portfolios either on Monday, 1st September 2025, or on dates such as 10th  September 2025 or 1st  October 2025, but you will still observe the price change between the sample period Monday, 1st September 2025 to Friday, 21st September 2025.

3.    This watchlist of Portfolio consists of Four stocks:

a.    Choose any Three stocks from Table 1 (on page 5) plus Tesla Inc. (TSLA)

b.   For Tesla stock, the number of Tesla shares must equal “the last three digits of your student ID”. For example, if your student I.D. is S3612345, you would hold 345 shares of Tesla in your portfolio.

c.    Determine the weights and shares for the rest ofthe stocks you chose in step a.

d.   You have USD 1 million for this Portfolio.

Note: Since the shares can’t be bought in fraction, a tiny variation from the specified budget is acceptable. You can choose to hold some Cash if you believe the investment opportunity is not good  enough,  but  you  will  need  to  justify  this  decision  in  your  report.  The  total  $1  million investment you have is based on the share prices on Monday, 1st September 2025.

4.    Take screenshots of your portfolio and the necessary information in all sections. Make sure you attach them in the Appendix of your submitted report.

5.    Suppose this is a Buy-and-Hold strategy, therefore, do not change your portfolio setting  during  your  holding  period Monday, 1st September 2025 to Friday 21st September 2025.

Questions and Marking Guide: Your report must include the following sections:

1. Trading philosophy: (2 marks)

Give an overview of your philosophy to form the portfolio. You should identify yourself as a value or growth investor or a mixture of both. Provide brief definitions for value/growth investing.

2. Portfolio construction: (6 marks)

Present your initial portfolio, including information on why you have invested in the stocks in your initial portfolio (three stock selection for Portfolio).

a.   The overall market and macroeconomic condition (3 marks)

b.   Industry consideration and/or diversification, specific stock’s strengths/positive prospects (3 marks)

3. Risk identification: (22 marks)

In this part, you should discuss the risk profile of your portfolio. On Monday, 1st September 2025, calculate the VaR of your Portfolio using 2-year daily historical stock price between 28th August 2023 (inclusive) and 29th August 2025.  The discussion should include the following points:

a.   Calculation and discussion of the one-day 99% Value at Risk of each stock in your portfolio using historical simulation approach. That means, if you have four stocks in total, you need VaR for each. Show key steps of workings. (4 marks)

b.   Calculation and discussion of the 10-day 95% Value at Risk of your portfolio using historical simulation approach. Show key steps of workings. (4 marks)

c.   Calculation and discussion of the 10-day 95%-Value at Risk of your portfolio using a model-building approach. Show key steps of workings. (4 marks)

d.   Discussion  of  the  performance  of  VaR  in  (b)  and  (c),  by  comparing  your calculated  VaR  results,  and  the  portfolios’  actual   10-day  returns  from 1st September 2025 to 12th September 2025. (6 marks)

e.   Calculation and discussion of the one-day 99%-Expected Shortfall (CVaR) of your  portfolio  using   a  historical   simulation  approach.   Show  key   steps  of workings. (4 marks)

Note: VaR template can be found in Week 11’s material on Canvas. You can download historical stock prices from MarketWatch as a CSV file, but it limits the maximum data to one year at a time, so you'll need to download multiple times for longer periods. As an illustration, this is the link to the historical daily prices of the Tesla stock. You're also welcome to use Yahoo Finance to obtain historical data, but  be  aware that  it will only appear as a screenshot, not as a CSV download, without a Gold subscription.

4. Hedging using Options: (10 marks)

Suppose you hold the portfolio until the submission date, on any day between Monday, 1st September 2025 and the submission date - 10th October 2025, you will use the option contract to hedge any one of your three selected stocks (excluded Tesla) in your Portfolio. (Please take the screenshot of option quote and spot price as of the same day and attach them in the Appendix of your submitted report).

a.   You need to determine and explain which option you want to use (i.e., specify whether it is a call or put, the transaction date, when the expiration date is, appropriate  strike  price,  whether  you  should  go  long  or  short,  number  of contracts, etc.). Provide justification for your decision. (6 marks)

b. Discuss when you will exercise your option and its potential payoff. (2 marks)

c. To  further  manage  your  portfolio  risk,  you  decide  to  explore  combining  the protective put with a covered call, where you write a call option on the same stock  you  are  hedging.  Describe  how  combining  your  protective  put  with  a covered  call  creates  a  more  complete  hedge  (i.e.,  a  collar).  In  your  answer: Specify the strike price and expiry of the call option you will sell and justify your choice. Explain how this addition changes the overall payoff of your position. Compare  the  trade-off between  the  reduced  cost  of hedging  and  the  capped upside. Support your explanation with a payoff diagram or table. (2 marks)

Note: The budget for option transactions (option price per share) is limited to within 1.5% of the stock’s market price and is not included in the initial $1 million budget (for either call or put options). You can construct the option trading strategy anytime during the portfolio holding period.

5. Hedging using Swaps: (10 marks)

As an Australian-based investor, you want to borrow 1 million U.S. dollars at a fixed interest rate to match your investment  cash  flows.  To  achieve  this,  you  enter  into  a  two-year currency swap agreement with Mrs. Phoebe Phan, who wishes to borrow Australian dollars at a floating interest rate. The amounts required by both parties are roughly the same at the current exchange rate. You and Mrs. Phoebe Phan have been quoted the following interest rates, which have been adjusted for the impact of taxes:

Design a swap that will net a bank (Bank A), acting as an intermediary, 20 basis points per annum. Unlike a swap equally attractive to both parties, this task requires you to design a swap that allocates 60% of the advantage (i.e., gain) to you and 40% of the advantage (i.e., gain) to Mrs. Phoebe Phan. Determine the rates of interest that you and Mrs. Phoebe Phan will end up paying. Provide an explanation, list your calculation process, and use a figure to illustrate the swap structure.

Total=50 marks

Note:

●      To complete tasks 1-4, you are required to use/download relevant historical stock price data. For task 5 (Hedging using swap), please use the information given only. No additional data is needed.

●      Besides  the  working  steps/summary  of key  results  of your  calculations  should  be discussed in the report, you also need to submit a separate Excel file to Canvas to show your detailed calculations.

●      This  instruction  includes  suggestions  on  items  to  include  in  the  report,  more information for parts you think are important may be included as you feel necessary, keeping in mind the word limit.

●      The  teaching  team  is  not  supposed  to  comment  on  your  calculation  workings  or identify your calculation mistakes. The teaching team will provide guidance to make sure that you are on the right track. However, it is still your responsibility to investigate your work and identify the errors.

Submission

•   All submissions must be made electronically on Canvas, accompanied by a cover sheet  through  Canvas  =>  Assignments  =>  “Assessment 3: Individual Risk Management Report”.

•   The report should follow a structured format, starting with an executive summary and followed by sub-sections addressing all questions/tasks. Essential components of the report include page numbering,  sections numbering, main body, executive summary, reference list, introduction and conclusion.

•   The report should be no longer than 2500 words (-/+  15%), excluding executive summary,   references   and    appendix.   The    student   can   have   up   to    2-page appendix.

Citation and reference must be provided. The Excel file contains your workings to support the reported analysis.

•   The submission must be using 1 or 1.5 spacing and 12-point Times New Roman font.

•    Students must  ensure  their reports  are  free  from  academic  issues  like  copying, plagiarism,   sharing   work,    collusion,   and    collaboration   with   other    groups, maintaining a similarity rate below 30%. Academic misconduct can result in course failure, permanent academic records, and graduation delays due to the investigation time by the COBL Integrity office.

•   Students are required to keep back-ups ofall submitted work just in case any are lost.

Table 1 List of stocks