FIN303 Financial Risk Management Coursework

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FIN303 Financial Risk Management Coursework
(30% of the Module Mark)

You are required to work on this project as a group to gain hands-on experience with financial data from security markets, allowing you to apply theoretical concepts to real-world scenarios. This collaborative project will not only enhance your understanding of market dynamics but also improve your skills in data analysis, teamwork, and problem-solving, which are essential in the field of financial risk management.

Project Content:

Select N investment instruments (e.g., stocks or indices) from the Shanghai or Shenzhen Stock Exchange and assume that you have RMB 10 million. If individual stocks are used, they must be from the same industrial sector. Download the daily prices of your chosen investment instruments (for example, stocks) over the sample period from the last trading day of 2004 to the last trading day of 2024 (from Wind/Bloomberg/CSMAR/WRDS, at your choice). Compute their simple returns (i.e., percentage changes). In this coursework, we choose N=3.

Question 1

a) Briefly introduce the N instruments of interest, compute the simple returns (i.e., percentage changes) for the N investment instruments and provide their summary statistics in a table, i.e., mean, standard deviation, max and min values, skewness, kurtosis, the number of observations, and the covariance matrix. (5 marks)

b) Plot the efficient frontier of N-stock investments and describe the salient features of it. [Hint: randomly generate 10,000 possible portfolios to visualize the efficient frontier] (5 marks)

c) Assuming the annualized risk-free rate is 2%, find the optimal weights of the N assets that maximize the Sharpe ratio. (5 marks)

Question 2

Please employ the optimal portfolio (with the highest Sharpe ratio) obtained in Question 1.c) in addressing the following questions:
a) Using the Normal Distribution and Historical Simulation methods, please calculate and discuss the 1-day VaR at a 90% confidence level based on the past 250 days for the N individual investment instruments. (10 marks)
b) Using the Model-Building approach and Historical Simulation method, please calculate and discuss the 1-day VaR at a 90% confidence level based on the past 250 days for the optimal portfolio. (10 marks)
c) Compare the portfolio VaR obtained in b) with the VaR estimates of the three individual investment instruments in a). Are there any benefits of risk diversification and why? (10 marks)
d) Back-test the above three 1-day VaR models based on the realized profit and loss of the N investment instruments and the optimal portfolio using a Binomial test at a significance level of 5%. Then compare and discuss these 1-day VaR estimates using different methods. (10  marks)
e) Interpret the results to see what you have learned by comparing different scenarios (i.e., subsamples). For example, during the extreme market conditions, e.g., 2008 financial crisis and the COVID-19 pandemic, do the VaR estimates tend to overestimate or underestimate the risk and why? If you were a bank supervisor, what suggestions would you provide to address this issue and ensure adequate capital requirements? (10 marks)

Question 3

a) Estimate the GARCH(1,1) model for N investment instruments and discuss how good is the model to fit the data. (10 marks)

b) With the results in a), discuss how volatility behaves during extreme market conditions, e.g., the 2008 Financial Crisis and the COVID-19 pandemic. What do you think could lead to the volatility spikes during these periods? (10 marks)

c) With the GARCH(1,1) model estimated in 3.a), using the Model-Building approach, please calculate and discuss the 1-day VaR at a 90% confidence level based on the past 250 days for the optimal portfolio obtained in 1.c). Please employ the backtesting (binomial test) to evaluate the accuracy of the VaR. Compare the results with those obtained in 2.b) and comment on the role of GARCH model in such an exercise. [Hint: also need to use the GARCH(1,1) model to estimate covariance] (15 marks)

Further information on the assignment will not be provided. Each group should undertake their own research and make decisions on the approach to present and discuss the information required and the assumptions used. The module material (lectures, labs and textbooks) can provide agood basis to build upon but higher marks will be awarded for analysis that goes beyond these materials. Please provide references on all additional sources of information used (in the selection/discussion of assumptions used as well as the general analysis). The assignment should be structured as follows:

• The overall word limit on this Word file must be 2,000 words maximum. (excluding tables/figures/references).
• You must name both Word and Excel files with your group number as well as the last names of each group member. Only one member, on behalf of the group, needs to submit the group work on the Learning Mall. Please use A4 paper and 1.5 or double spacing for the commentary file. Pages should be numbered.
• The Word file will be mainly marked. The Excel file is regarded as an appendix. To improve the readability, the Excel file must be well-presented, clear and reader-friendly.
YOUR COMPLETED ASSIGNMENT MUST BE SUBMITTED NO LATER THAN 09:00, 26th May 2025 (Monday).

The soft copy (Word file plus Excel file) must be submitted on “Turn-It-In” through the Learning Mall FRM Coursework Submission link. Any late submissions will be dealt with according to school regulations.

Appendix A:
FIN303 Financial Risk Management
Group Contribution Form (if disagree)

If and only if you disagree that all group members made a valuable and equal contribution, please send this form back to me ([email protected]) by 30 May 2025, Friday, 12PM. Late appeal is not accepted.

If you agree that all group members made a valuable and equal contribution and therefore believe it is fair that each member receives the same grade for the coursework, you do not need to take any action.

Group number:
Individual Name (print):
%Contribution to the group project

%

%

%

%

%

100%

The adjusted CW mark for a student with a contribution of X% = Min (100, Orginal Mark × (1 + ?% − number of students 100% in a group)), where X%>0.
All Signatures:
1._____________________________
2._____________________________
3._____________________________
4._____________________________
5._____________________________
Appendix B:
FIN303 Financial Risk Management
Group Contribution Form (Free-Rider Problem)

If and only if there are one or more Free Riders in the coursework, who never get involved; that is the contribution to the coursework is ZERO, please send this form back to me ([email protected]) by 30 May 2025, Friday, 12PM. Late appeal will not be accepted.

If you agree that all group members made a valuable contribution and therefore believe it is fair that each member receives the same grade for the coursework, you do not need to take any action.

Group number:
Free Rider(s) Name (s):
Fill out the following form if and only if the remaining members disagree that you made an equal contribution.
Other Individuals’ Names (print):
 % Contribution to the group project

%

%

%

%

100%

The adjusted CW mark for a (non-free-rider) student with a contribution of X% = Min (100, Orginal Mark × (1 + ?% − number of non−free− 100% rider students in a group)), where X%>0.
A brief justification:
Other Individuals’ Signatures:
1._____________________________
2._____________________________
3._____________________________
4._____________________________

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