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How do I approach the following question?

A portfolio has 100 million invested in equities. It has also transacted an interest rate derivative issued by counterparty X, which the value is 0 if the reference interest rates are equal to or below 2% p.a., 5 million if the reference interest rate is between 2% p.a. and 3% p.a., and $15 million if the reference interest rate is higher than or equal to 3% p.a. The current reference interest rate is 2.5% p.a.

(i) What is the current value of the portfolio?

(ii) What is the current value of the portfolio if we subject the portfolio to three stress tests below:

Test 1: +1% p.a. reference interest rate and -25% market value of equities

Test 2: -1% p.a. reference interest rate and +25% market value of equities

Test 3: +2% p.a. reference interest rate, -50% market value of equities, counterparty X default with 50% recovery of the market value of the interest rate derivative.

(iii) Suggest the reasons for Tests 1 and 2 to be calibrated this way i.e positive direction for interest rate and negative direction for the market value of equities and vice versa.

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