Question 1. Market Risk

Refer to the following materials accompanying the Case “Implementing Quantitative Risk Management and VaR at a Chinese Investment Bank” covered in Lecture 5:

•    Case_Implementing VaR at a Chinese Investment Bank

•    Spreadsheet accompanying VaR in Chinese Investment Bank Case

Using the spreadsheet provided, run backtests of the VaR predictions against actual daily gains or losses for both the S&P500 Index and the Shanghai Composite Index.

1.1.      Based on varying lookback periods of 2, 3, 6, 9, 10 and 12 months, fill in the table below as

appropriate [2 marks]:

Table: Percentage of Exceptions | Total Back Test Fails

Note: insert Percentage of Exceptions and Total Back Test Fails in each cell

separated by a comma

Compare  and  comment  on  the  number  of exceptions for  both  the  S&P500  Index  and  the Shanghai Composite Index. From your comparison, is it reasonable to use the VaR model for the Chinese market compared to the US market? [3 marks]

1.2.      VaR is based on an assumption of normality. Discuss what you consider to be the main benefit

and main drawback of this assumption when modelling volatility. [5 marks]

1.3.      From the spreadsheet, calculate the average of the losses beyond VaR whenever exceptions

occur.  Compare and comment on the average of losses beyond VaR for the S&P500 Index and the Shanghai Composite Index. On the basis of your comparison, what is your opinion on the suitability of VaR for the Chinese market. Do you agree or disagree with the following statement:

“VaR indicates the loss size that will only be exceeded 5% of the time in this case but says nothing about how big the loss might be when the VaR threshold is actually exceeded. ”?

Justify your answer with reference to data from the spreadsheet. [5 marks]

Question 2. Operational and Technological Risk

2.1.      What is your view on what the bank of the future may look like? Briefly describe the

distinguishing features of its activities compared to ‘traditional’ banks. [5 marks]

2.2.      Based on the nature of the bank of the future’s activities that you have portrayed above, identify

and describe the risks the bank is likely to face compared to ‘traditional’ banks. Your answer should differentiate between ‘traditional’ and ‘emerging risks’ . [5 marks]

2.3.      Under the Basel III finalisation, the Basel Committee has eschewed the Advanced Management

Approach for operational and technology risk management. Briefly discuss the main reason for this change. [5 marks]

Question 3. Capital management

The table below is based on the annual financial statements of four major banks in Australia, ANZ Bank (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking Corporation (WBC).

3.1.      Based on your own research, why have some major Australian banks been engaging in share

buybacks in the past year? Your answer should explain the meaning of share buybacks and outline their rationale in terms of capital adequacy and bank profitability. [5 marks]

3.2.     Visit the websites of these banks and access the 2021 financial statements for each bank.

Report the dollar values of the following for FY21:

Common Equity Tier 1 (%)

Tier 1 Capital (%)

Tier 2 Capital (%)

Looking at the figures you have provided and the table above, rank the banks from 1 (most likely) to 4 (least likely) in terms of your assessment of the banks being in a position to engage in a share buy-bank in 2022. Justify your reasoning based on your understanding of Basel III    capital adequacy requirements. [5 marks]

3.3.      You are having a discussion with your classmates and one of them makes the following

observation.“In the corporate finance studies we learnt that credit risk is measured by the leverage ratio. Why then do we bother in this course to use risk-adjusted capital measure instead of the leverage ratio?”Respond, fully justifying your answer with example(s). [5 marks]