5. Risk management: (10 points) You are a CRO (Chief Risk Officer) supervising a portfolio...
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5. Risk management: (10 points) You are a CRO (Chief Risk Officer) supervising a portfolio manager who invests in two stocks AAL and AMZN. You have decided, for capital adequacy reasons, to impose a daily loss limit computed from the 'quantile' associated with the 10% lower tail of the expected daily portfolio return distribution for a $1,000,000 investment in an equally-weighted portfolio. Given the short forecast horizon, you assume that the expected returns for AAL and AMZN are zero and also that the correlation between the AAL and AMZN returns is zero. You have forecasted the one-day ahead variance to be 0.05% and 0.06% for AAL and AMZN respectively. (a) Please compute portfolio volatility (5 points) and also (b) compute your 90% confident daily loss limit (5 points). Be sure to explain each step of your calculation and the intuition in terms of VaR (Value-at-Risk). [The 10\% 'quantile' of the standard normal distribution is 1.28. You assume the normal distribution of daily returns]
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