PORTFOLIO SIMULATION & VAR Harvard Case Solution & Analysis

 PORTFOLIO SIMULATION & VAR Case Solution

Introduction

             In financial risk management, there have been a lot of approaches that had been employed in the use of risk optimization and simulation of the random variables which pose risk within a particular transaction. This brief report attempts to analyze an investment of portfolio consisting of two stock which is BP Amoco and Tesco stocks. The three simulation methods which have been employed in order to compute the changes in the portfolio and their relative value at risk are the historical simulation method using the excel spreadsheet, the traditional Monte Carlo Simulation method using the excel spreadsheet, the Linear Model and the Modern or Advanced Simulation Method using the excel risk optimizer called as @ Risk.

 Investment in 10 million shares of BP Amoco in the Oil and gas sector and 20 million shares of Tesco in the food and drug retailers sector has been made with an initial value of the portfolio being equal to 92.050 million pounds. Based upon the market and the historical prices of the stocks data, the mean, volatility, covariance, correlations and value at risk has been computed for the last year, last quarter, and last month and for the last 500 days of investment in this portfolio. Each of the simulation models and the calculations performed are interpreted separately in this report.

 Historical Simulation Model

             Before creating the simulation model, the mean returns, the volatility, covariance and the correlations for each of the two stocks has been computed for the whole period, last 500 days, last year, last quarter and for the last month. Moreover, based upon the sample market variable which is the share price, the revalued portfolio values have been computed and then the change in the portfolio has been computed. Finally, the appropriate percentile of the simulated changes has been computed which is 1 day Value at risk and using this the 10 day Value at risk has also been computed. The output is as follows:

VaR (for the whole period)OUTPUT

confidence level

95%

98%

99%

1 day VaR

-2.461

-3.451

-4.108

10 day VaR

-7.783

-10.914

-12.989

 It could be seen that the value at risk at the difference confidence levels is negative. This means that the portfolio would actually be making profits. In other words it could be said that this portfolio comprising of the two stocks has a high probability of making a profit..................

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