What are the four components of Risk Management and define each component.

The project is worth 55 points. Each question is worth 5 points.

The questions relate to chapters 1,3,4,5, & 8 of the Hull book and the lectures.

If you have any calculations, please show them in your answers.

1.

Are risk and uncertainty the same or different? If they are different, explain the differences.

2.

What are the four components of Risk Management and define each component.

3.

What are the key differences between a defined contribution plan and a defined benefit plan and who

bears the risk for each plan?

4.

In a given year, interest rates fall by 300 basis points (3%) and equity prices are flat. Discuss the effect of

this on a defined benefit pension plan that is 60% invested in equities and 40% invested in bonds. (Show

any calculations).

5.

As the Chief Risk Officer of Bitcoin Inc., you need to determine the weighted probability of returns of the

firm’s $10 million allocation to bitcoin.

Below is a probability table of potential returns for the firm’s bitcoin investment:

Return Probability

200% 2.5%

100% 5%

45% 20%

15% 31%

-15% 18%

-30% 14%

-60% 9.5%

A. Calculate the weighted probability of returns in a percentage and dollar amount (show the

calculations).

B. Based on the above table, what is the maximum dollar amount the portfolio could return?

C. Based on the above table, what is largest dollar loss the portfolio could experience?

6.

The price of gold is currently $1,400 per ounce. The forward price for delivery in one year is $1,650. An

arbitrageur can borrow money at 3% per annum.

What should the arbitrageur do and why? Assume that the cost of storing gold is zero and that gold

provides no income. (Show any calculations)

7.

A. Define contango and backwardation of a futures market.

B. What would cause a futures market to move from contango to backwardation?

8.

If a futures market is in contango, is the roll yield positive or negative and why?

9.

A. If a call’s strike price is above market price, what is the option moneyness and does it make the price of

the call expensive or cheap and why?

B. If a put’s strike price is above the market price, what is the option moneyness and does it make the

price of the put expensive or cheap and why?

10.

Options are wasting assets.

A. As a wasting asset, which of the “Greeks” derives the rate of change of an option’s value?

B. Is the value of this “Greek” usually positive or negative and why?

11.

What position is equivalent to a long forward contract to buy an asset at K on a certain date and a long

position in a European put option to sell it for K on that date? (Show any calculations)

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