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Portfolio ManagementUnit 4 – Case Study: Enterprise Risk Management System for Ford Motor CompanyStewart Gilchrist follows the automotive industry, including Ford Motor Company. Based on Ford’s 2003 annual report, Gilchrist writes the following summary: Ford Motor Company has businesses in several countries around the world. Ford frequently has expenditures and receipts denominated in non-U.S. currencies, including purchases and sales of finished vehicles and production parts, subsidiary dividends, investments in non-U.S. operations, etc. Ford uses a variety of commodities in the production of motor vehicles, such as nonferrous metals, precious metals, ferrous alloys, energy, and plastics/resins. Ford typically purchases these commodities from outside suppliers. To finance its operations, Ford uses a variety of funding sources, such as commercial paper, term debt, and lines of credit from major commercial banks. The company invests any surplus cash in securities of various types and maturities, the value of which are subject to fluctuations in interest rates. Ford has a credit division, which provides financing to customers wanting to purchase Ford’s vehicles on credit. Overall, Ford faces several risks. To manage some of its risks, Ford invests in fixed-income instruments and derivative contracts. Some of these investments do not rely on a clearing house and instead effect settlement through the execution of bilateral agreements. Based on the above discussion, recommend and justify the risk exposures that should be reported as part of an Enterprise Risk Management System for Ford Motor Company.Answer:The following risk exposures should be reported as part of an Enterprise Risk Management System for Ford Motor Company:a). Market risks:Currency risk, because expenditures and receipts denominated in nondomestic currencies create exposure to changes in exchange rates.Interest rate risk, because the values of securities that Ford has invested in are subject to changes in interest rates. Also, Ford has borrowings and loans, which could be affected by interest rate modity risk, because Ford has exposure in various commodities and finished products.b). Credit risk, because of financing provided to customers who have purchased Ford’s vehicles on credit.c). Liquidity risk, because of the possibility that Ford’s funding sources may be reduced or become unavailable and Ford may then have to sell its securities at a short notice with a significant concession in price.d) Settlement risk, because of Ford’s investments in fixed-income instruments and derivative contracts, some of which effect settlement through the execution of bilateral agreements and involve the possibility of default by the counterparty.e) Political risk, because Ford has operations in several countries. This exposes it to political risk. For example, the adoption of a restrictive policy by a non-U.S. government regarding payment of dividends by a subsidiary in that country to the parent company could adversely affect Ford.An analyst would like to know the VaR for a portfolio consisting of two asset classes: long-term government bonds issued in the United States and long-term government bonds issued in the United Kingdom. The expected monthly return on U.S. bonds is 0.85 percent, and the standard deviation is 3.20 percent. The expected monthly return on U.K. bonds, in U.S. dollars, is 0.95 percent, and the standard deviation is 5.26 percent. The correlation between the U.S. dollar returns of U.K. and U.S. bonds is 0.35. The portfolio market value is $100 million and is equally weighted between the two asset classes. Using the analytical or variance–covariance method, compute the following:A. 5 percent monthly VaR.B. 1 percent monthly VaR.First, we must calculate the monthly portfolio expected return and standard deviation. Using ‘‘1’’ to indicate theU.S. government bonds and ‘‘2’’ to indicate theU.K. government bonds, we haveμP = w1μ1 + w2μ2 = 0.50(0.0085) + 0.50(0.0095) = 0.0090= (0.50)2(0.0320)2 + (0.50)2(0.0526)2 + 2(0.50)(0.50)(0.0320)(0.0526)(0.35)= 0.001242σP =√0.001242 = 0.0352For a 5 percent monthly VaR, we have μP ? 1.65σP = 0.0090 ? 1.65(0.0352) = ?0.0491. Then the VaR would be $100 million(0.0491) = $4.91 million.B. For a 1 percent monthly VaR, we have μP ? 2.33σP = 0.0090 ? 2.33(0.0352) = ?0.0730. Then the VaR would be $100 million(0.0730) = $7.30 million. ................
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