Value at Risk (VAR) of a portfolio of 4 shares Assignment

Value at Risk (VAR) of a portfolio of 4 shares - Assignment Example This research aims to evaluate and present risks the financial institutions face with. Credit risk deals with the potential loss resulting from inability of a counterpart to adhere to its obligations. It is characterized by three basic components this being; credit exposure, loss in the event of default and probability of default. Liquidity risk is mainly caused by unforeseen outsized and stressful off-putting cash flow over a short span of time. A firm may be obliged to put up for sale some of its assets at a markdown, if it has vastly illiquid assets and suddenly requires liquidity. Market risk looks at the variations in market conditions and stipulates the uncertainties likely to occur to future earnings. Finally, operational risk includes the risk of regulatory and fraud. It mainly takes into account the errors made in settling transactions or instructing expenditure. Market risk is the most prominent; it highlights the potential economic loss as a result of a decrease in the por tfolio’s market value. Value at Risk (VaR) is the best measure that financial analyst can use to compute this risk. VaR is defined as a portfolio’s maximum potential loss value of financial instruments over a certain horizon with given probability. In this report, we are using the data obtained of four different companies. These data are composed of the total return indices of the four companies for the last ten years. VaR is a challenging statistical problem, though its existing models for calculations employ different methodologies they still follow a general structure. This structure involves three steps: a) Mark to market the portfolio, b) Approximate the distribution of returns, c) Calculate the VaR of the portfolio. The difference in the methods that are used to find VaR lie in step 2, because of the way they address the hitch of how to approximate the possible variations in the significance of the portfolio. For example, CAViaR models do not take account of the distribution matter; the quartile of the distribution is calculated directly in this case. There are a number of methods used in calculating the VaR value; in this report the main methods to be used are the Monte Carlo, Analytic and Bootstrap VAR. The report gives detailed results of all the three methodologies in a systematic manner, with data sample of a 260-day from the provided data of the portfolio shares for the four companies. The data are based on the total return index which takes into account the dividend level which is essential in valuing shares, unlike the price data sample. Background to the data sample The data are sampled from a ten year record of four individual companies, Kingfisher PLC, GKN PLC, Admiral PLC and Burberry PLC. Kingfisher PLC; is a company operating in the retail industry, founded in 1982 by Paternoster Stores Ltd. It expanded through successive acquisitions like Superdrug and B&Q. The company is a multinational now headquartered in London, UK. The c ompany provides products such as home appliances, garden supplies & plants, tools and hardware mostly home improvement products. It deals with brands such as B&Q, Brico Depot, Screwfix and Castorama. Its chain of stores is nearly 900 spread across eight countries in Asia and Europe. GKN PLC; found in the automotive and aerospace industry, its origin dates back to 1759 in the early stages of the industrial revolution. The company is a