Risk of a Single Cash Position
BetaSquare are a USD-based firm with one asset: JPY 14 billion in cash. What is the 95% worst-case loss over a 1-day period?
You have the following information:
The daily price volatility of the JPY/USD exchange rate is 1.78%, using a 95% confidence level. (Note: This implies that 1 standard deviation equals 1.78%/1.65 = 1.08%.)
The JPY/USD exchange rate is 140.
|1. Choose a probability of loss||5%||=95% confidence worst-case loss|
|2. Measure value in USD||$100 million||Assuming 140 JPY/USD|
|3. 1-day volatility JPY/USD (or 1.65 standard deviations)||1.78%||Data Set|
|4. Calculate Risk||$100 million * 1.78 =$1.78||Market value volatility|
This means that your 95% worst-case loss due to adverse movements in the JPY IUSD over 1 day would be $1.78 million (or, you have a 5% chance of losing $1.78 million or more overnight). Now let's view an example of two cash positions. To calculate the total risk of two or more positions, however, we need to include correlations.