Market Risk and VaR
The Dow Jones Industrial Average (DJIA) is comprised of thirty (30) “bluechip”U.S. stocks. At 100-plus years, it is the oldest continuing U.S. market index. It is called an “average” because it originally was computed by adding up stock prices and dividing by the number of stocks. The DJIA is the best known market indicator in the world, partly because it is old enough that many generations of investors have become accustomed to quoting it, and partly because the U.S. stock market is the globe’s biggest.
Assume that you have decided to invest $ 1 million in ETF fund that replicates opposite (inverse) daily investment results which correspond to two times (-2x) the daily performance of the Dow Jones Industrial Average index. Traders and investors who buy this ETFs actually take a short position in the market.This kind of ETF strategy are called inverse ETFs as it allows to inversely track an index or underlying asset without having exposure to margin restrictions or short selling since the risk will be transferred to the ETF fund.
Against this backdrop, it is important to measure and quantify risk in such high risk investment strategy as ETFs are subject to financial risk, fluctuate in market value and may trade at prices above or below the ETFs par value. Therefore, you need to carry out market risk analysis. In this assignment students are required to answer the following questions which will facilitate a market
risk analysis.
Q1) Replicate Dow Jones Index performance over last year (Jan 1, 2013 -Dec 31, 2013) using weights and components in attached excel file, gear up performance by -2X (hint: consider trading leveraged strategy) and then describe main characteristics of this portfolio such as performance chart, return and risk on return and price basis? (10 marks)
Q2) Discuss market risk in this investment strategy and identify source of risk in US stock market in general (Hint: consider the impact of monetary policy) ? (20 marks)
Q3) Calculate historical VaR with significance level at 5% and 1-day holding period ? (10 marks)
Q4) Calculate variance/covariance VaR with significance level at 5% and holding period is 1-day ? (10 marks)
Q5) Calculate Monte Carlo VaR with significance level at 5%, 1-day holding period and interest rate (r) at 1% ? (10 marks)
Q6) Compare results and identify must reasonable VaR based on your assumptions and methodology comparisons ? (20 marks)
Q7) Discuss and comment on VaR ? (10 marks)

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