1) Consider a zero coupon bond with 10 years maturity with face value $100. The internal rate of return (IRR, y) is 8% and the daily volatility of the IRR is 0.0007 (7 basis points). Required: • Compute the percentage VaR over 1-day and under 99% confidence level. • Compute the dollar VaR over 1-day and under 99% confidence level.
2) Consider the risk of a short position on a call option. The VaR of its underlying asset is 2000. The delta of this option is 0.5.
Required: • Compute the linear VaR of the option • Discuss how the gamma effect would affect the linear VaR of the option.
3) A local linear valuation method is appropriate to compute VaR if the portfolio contains complex options.
Required: • Discuss whether the above statement is correct or not. • Discuss which methodology is more suitable to compute VaR
4) Discuss how the backtesting is used to test the accuracy of VaR over 1-day and under 99% confidence level.