Financial Risk Management (N1569)
Seminar Topic 6 VaR for Cash Flows
A. Sketch the cash flows for:
1. Receipt of a 5-year interest-only (not interest + pay-down) loan of $10m with a fixed annual interest payment of 4%.
2. Purchase of a 3-year bond with a coupon of 5% paid annually.
B. You have a cash flow of $6m at 7 years, when the 7-year interest rate is 5% with a volatility of 45 bps. You want to map this to two vertices: the 5-year interest rate, which is 4% with a volatility of 50bps; and the 10-year rate which is 6% with a volatility of 40bps. The correlation between the 10-year and 5-year interest rates is 0.75.
1. Find the PV (in $m) and the PV01 (in $) of the original cash flow.
2. How much of this PV is mapped to each vertex, in order to keep PV constant and to keep the volatility of the mapped cash flow the same as the volatility of the unmapped cash flow?
3. Calculate the PV01 of the mapped cash flow at each vertex.
Adapt the Excel file ‘Cash Flow Map’ for your solution.
C. The Excel file for the part of the seminar has monthly interest rates at vertices 1, 2, 3, 4, 5, 7, 10, 15 and 20 years from 2017 to 2020. Another spreadsheet gives the PV01 vector of sensitivities representing a cash flow portfolio. Use these data to calculate the 1% annual VaR of the portfolio using the normal linear model.