ee? | TSE Année Universitaire 2013-2014 ‘SESSION 1 MASTER 2- TSE FINANCIAL MARKETS: (durée 3h00) | Friday December 20th 2013 ~ 9h30 -12h30 8. VILLENEUVE A-GUENBEL Exercice Optimal decision to buy Insurance Consider an individual confronted with a risk of accident X that may cause a loss L with probability p. ‘The individual owns a wealth W > Z. He can fully insure the risk by paying a premium 7 or retain it, We suppose that the agent utility is given by UW) = nw). 1. What is the agent’s expected utility if he fully insures his risk? 2. What is the agent's expected utility if he retains his risk? 3. What is the certainty equivalent (that is the amount of money that gives the same utility in the two eases) C' of this risk? 1. What is the maximum premium 7* the agent is willing to pay to insure this tisk? 5. What happens if p increases? Comments? Exercise 2: Value at Risk and Commercial Bank Solvency A commercial Bank has the following balance sheet at time 0,1 We suppose that the deposits D are constant (D = Dy) and that the assets evolve as Ay = Aexp(oX) where X is a standard gaussian random variable. We denote ¢ the distribution function of At time 1, the bank will be unsolvent if 4) < D or equivalently £, < 0. We defiue the Value at at level as the level of equity capital E needed to be sure with probability a to be solvent at time 1, that is VaRq = inf{E € R, P(E, > 0) = a} 1. Express in terms of B.A and X 2. Compute the Value at Risk at level a of Ey u Bo 3. Compute the default probability p = P(A; < D) as a function of the initial equity capital Z. 4. Give the | of E suring that p is equal to 1a in terms of the value et Risk What is the static comparative of E, with respect to ? Con AExercise 3: Mean variance investor ‘We consider a financial market with two assets, one risk-free bond with an interest rate normalized to zero and one risky share whose price at time 0 is Sy and return is a random variable X with -ani pe and variance ¢, We consider a self-financing portfolio characterized by (b,a) where wealth invested in th an value of the agent's wealth is Wo is the is the wealth invested in the risky asset. We assume that the 1, Express the portfolio value at time one W; as a function of Wo and a. 2. Compute the expected value and the variance of W/, Compute the level a*(7) that maximizes 2(W;) — yVar(W;) for a risk aversion coefficient + 4, Consider a firm that sell the risky asset at time 1. In order to hedge risk, the manager is willing to sell 0% of the risky asset using futures contracts at price F. Assuming the manager uses a mean-variance criterion, what is the optimal futures position?