Risk Management Simulation Guide

  BANK 3003 (SP5)

Financial Risk Analysis

Course Coordinator: Hao Zhou

The Purpose

This assignment should be completed in groups of 1-4 students. This assignment focuses on the analysis of authentic market data and company financials. It is designed to enhance students’ knowledge in the following: an understanding of and ability to identify and quantitatively assess the financial risks faced by corporations; an ability to identify securities for hedging purposes; familiarity with the construction of tables and graphics and their integration into written reports; and high-level written communication skills.

The Task:

  • Choose any non-financial company within the S&P/ASX 50 index.

(Hint 1: You should identify risk exposures with clear dollar value and timing. For example, you might discover that your company is going to sell $10 million worth (dollar value) of copper in the next 6 months (timing). As a result, the company is exposed to the risk of copper price fluctuations in the next 6 months. It is likely that this sale is exposed to AUD/USD foreign exchange rate risk since copper is priced in USD. However, please do not use a single transaction for two market risk exposures.)

(Hint 2: You can identify these exposures using any financial reporting or news. Most of the S&P/ASX 50 companies have extensive documentation on their website, the IRESS platform, and other sources.)

  • Through the IRESS trading platform, identify securities and realistic methods to hedge the risk. By means of diagrams, graphically illustrate the risk exposure, the payoff associated with the hedge chosen, and the overall hedged result. Briefly comment on your results.
  • Quantitatively assess the riskiness of the underlying risk factors. Form a portfolio with weights based on the value of the two exposures and assess the riskiness of the portfolio. Comment on your results and discuss how your results from your analysis in this part would change your hedge strategy.

(Hint: You should download monthly pricing data over the last 5 years for your risk factors from IRESS. At minimum, you should calculate the mean, standard deviation, and correlations of the risk factors and the portfolio. Additional measures are encouraged and rewarded.)

The Report:

Prepare a report in which you:

  1. Provide a brief overview the company you are investigating, as well as the sources of market risk to which you would have an exposure. Cite the financial reporting or news items from which you have identified the exposures. For long documents, such as financial statements, page numbers should be included in your in-text citations.
  • Using the IRESS Trading Room platform, identify one or more securities that provide a practical hedge for each exposure. Provide brief details on each of the hedge securities chosen and the position you would take in each of the hedge securities. Use screenshots as citations for the specifications and prices of the hedge securities. Provide an example calculation to illustrate how the derivatives payoff, exposure payoff, and net payoff are estimated.
  • For each risk exposure, provide a payoff diagram to illustrate the risk exposure and, on the same diagram, overlay the payoff of the hedge security and the net payoff of the combined position. Briefly comment on the results.
  • Present and interpret your quantitative analysis of the risk factors and the combined portfolio. Discuss these findings in relation to your results from parts 2 and 3.

What to Submit and When?

Each group should submit one copy of the following via learnonline by 5pm, 22 Oct 2021:

  1. A WORD file (of no more than 2 pages of writing). Supporting materials, such as formulas, calculations, tables, figures, references, and appendices, do not count towards the page limit. There is no word limit. The word limit shown in the course outline is the ‘word-equivalent’ limit. It does not strictly apply because we have quantitative elements.
  2. An Excel file for reference to the calculations and sources used. This file is not graded. The grader may reference the Excel file if the main report is unclear or ambiguous. Therefore, there are minimum expectations in terms of formatting and explanation.

Forming your group

This Assignment should be completed by students working in groups of 1 to 4 students. Students are free to form their own groups. Internal and externals students can be in the same group. It is noticeable that early and deliberate group formation is associated with successful assessment outcomes. Only one final assignment per group should be submitted.

Feedback form for Financial Risk Simulation

 Assessment feedback  
Qualitative aspects (35%) • Overview of the company and proper justification for the risk exposures chosen • Discussion on the hedge strategy and results • Discussion on the riskiness of the risk factors and the portfolio risk       
Quantitative aspects (35%) • Calculations for the hedge strategy and hedge outcome • Calculations for the risk factors and for the portfolio risk • Additional quantitative analysis if applicable, and if it yields relevant insights. • Proper interpretations and succinct presentation       
Style (15%): Appropriate layout; Proper formatting for tables, figures; Appropriate referencing       
Presentation (15%): Legible and well set out; Arguments presented in a clear and logical manner; Correct grammar; Absence of typos, incomplete sentences, and confusing expressions       
Additional comments:  
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