Case 008Risk management and limit breachesCore
A Rs 1,000 crore balanced fund holds domestic equity, unhedged US equity, corporate bonds and gilts. Apply a crisis scenario with equities down 55%, spreads up 400 basis points, gilt yields down 150 and the rupee down 20%. What is the loss, and what actually hedged?
1The situation
Dharitri Balanced Fund has Rs 1,000 crore: 55% in Indian equities, 10% in US equities with no currency hedge, 20% in corporate bonds with a spread duration and a rate duration of 3, and 15% in gilts with a duration of 6.
The risk committee wants a crisis scenario run: equities everywhere fall 55%, corporate credit spreads widen 400 basis points, gilt yields fall 150 basis points as money runs to safety, and the rupee weakens so that a dollar buys 20% more rupees. Ignore convexity.
2Your task
Total the loss sleeve by sleeve, and say which holdings actually protected the fund.
Quick check
Roughly how much does Dharitri lose in the scenario?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Dharitri loses about Rs 350 crore, 35.0% of the fund. Equities lose Rs 357.5 crore. The weaker rupee adds back Rs 9.0 crore on the unhedged US holding and gilts gain Rs 13.5 crore, but corporate bonds lose Rs 15.0 crore as spreads widen. Taken together the 35% in bonds changed the result by only Rs 1.5 crore: in this crisis only gilts and the dollar hedged.
Step 1How do you run a scenario without losing the thread?
Go sleeve by sleeve and apply only the shocks that sleeve is exposed to, then add. Each sleeve's loss is its size times its sensitivity times the shock, and the sensitivity for a bond is its duration. A household budget in a bad year works the same way: the salary cut hits one line, a rise in rent another, a fall in the price of petrol helps a third, and the total is the sum of the lines.
Step 2What does each sleeve lose or gain?
Indian equity: Rs 550 crore times minus 55%, a loss of Rs 302.5 crore. US equity: Rs 100 crore falls to Rs 45 crore in dollars, but each dollar now buys 20% more rupees, so it is worth Rs 54 crore: a loss of Rs 46 crore instead of Rs 55 crore, because the unhedged currency paid Rs 9 crore. Corporate bond yields move by the gilt fall plus the spread rise, minus 150 plus 400, so up 250 basis points: at a duration of 3 that is minus 7.5%, Rs 15 crore. Gilts gain 6 times 1.5%, 9%, Rs 13.5 crore.
| Sleeve | Rs crore | Shock applied | P&L, Rs crore |
|---|---|---|---|
| Indian equity | 550 | -55% | -302.5 |
| US equity, in dollars | 100 | -55% | -55.0 |
| US equity, currency | dollar +20% on Rs 45 crore | +9.0 | |
| Corporate bonds, spread | 200 | 3 x 4.0% | -24.0 |
| Corporate bonds, gilt yields | 3 x -1.5% | +9.0 | |
| Gilts | 150 | 6 x -1.5% | +13.5 |
| Total | 1,000 | -350.0 |
Step 3Which holdings actually hedged, and why does that matter?
Gilts and the unhedged dollar did; corporate bonds did the opposite. A corporate bond is part gilt and part credit, and in a crisis the credit part wins: the spread loss of Rs 24 crore swamped the Rs 9 crore the lower gilt yields gave it. So Dharitri's 35% in bonds, which a client reads as the safe part of a balanced fund, moved the result by just Rs 1.5 crore. That is the finding to take to the committee: if the fund wants protection in a crisis, the protection is in the gilts, and the corporate sleeve behaves more like equity when it matters.
Say the limits. A scenario is one story, not a probability. The gilt rally assumes a flight to safety; in an inflation shock gilts can fall with equities and the cushion disappears. The rupee has often weakened in global sell-offs, but not always, and ignoring convexity slightly understates the gilt gain.
Where candidates lose it
The quick answer multiplies the 65% in equities by 55% and stops at Rs 357.5 crore. It happens to land close, but for the wrong reason: two cushions and one extra loss roughly cancelled, and the committee needs to know which is which.
The second loss is applying only the spread shock to corporate bonds. Their yield is the gilt yield plus the spread, so both moves apply, and the net is a rise of 250 basis points, not 400.
What the interviewer asks next
- Rerun the scenario with gilt yields rising 100 basis points, as in an inflation shock. What is the loss now?
- What would hedging half the US equity's currency have cost the fund in this scenario?
- How would you shift the bond sleeve to give more crisis protection without changing the equity weight?
- How is a scenario like this different from a value at risk number?
Company names and figures are illustrative.