Question 1

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the true default probability?

Accepted Answer

A)  13.0% 
B)  20.5% 
C)  38.3% 
D)  44.4% 
A)  13.0% 
B)  20.5% 
C)  38.3% 
D)  44.4% A

Question 2

What is a credit default swap and what function does it serve?

Accepted Answer

A CDS makes a payment when a specific credit event occurs.A CDS serves to provide insurance against credit risk,specifically default.An insuring party provides payment in case of default.

Question 3

Credit risk has always existed.Since the early 1990s,credit derivatives have become dominant in the capital markets.How do these instruments serve to reduce and/or transfer risk? Can you think of ways in which the existence of credit derivatives has made the financial markets more efficient?

Accepted Answer

Credit derivatives serve to reduce and transfer credit risk in several ways. Firstly, they allow financial institutions to hedge their credit exposure by transferring the risk to other parties. This can help to reduce the overall level of risk in the financial system by spreading it across a wider range of market participants. Additionally, credit derivatives can also be used to create customized risk management solutions, allowing institutions to tailor their risk exposure to specific needs and preferences.

Furthermore, the existence of credit derivatives has made the financial markets more efficient in several ways. Firstly, they have facilitated the trading and pricing of credit risk, allowing for more accurate and transparent valuation of credit exposures. This has in turn led to greater liquidity in the credit markets, as investors are able to more easily buy and sell credit risk. Additionally, the use of credit derivatives has also allowed for the transfer of credit risk to those parties best able to bear it, leading to a more efficient allocation of risk within the financial system.

Overall, credit derivatives have played a significant role in reducing and transferring credit risk in the financial markets, while also contributing to greater efficiency and liquidity in the credit markets.

Question 4

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 4%,σ = 25%,and δ = 0.If the asset has a 2% chance of total default,what is the yield on the bond?

Accepted Answer

A)  8.32% 
B)  12.33% 
C)  24.36% 
D)  36.85% 
A)  8.32% 
B)  12.33% 
C)  24.36% 
D)  36.85%

Question 5

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 4%,σ = 25%,and δ = 0.If the asset has a 2% chance of total default,what is the value of the debt?

Accepted Answer

A)  $67.10 
B)  $75.19 
C)  $85.62 
D)  $90.00 
A)  $67.10 
B)  $75.19 
C)  $85.62 
D)  $90.00

Question 6

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 5%,σ = 15%,and δ = 0.If the asset has no chance of total default,what is the value of the debt?

Accepted Answer

A)  $67.10 
B)  $75.19 
C)  $85.62 
D)  $90.00 
A)  $67.10 
B)  $75.19 
C)  $85.62 
D)  $90.00

Question 7

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the recovery rate assuming risk neutral default probability?

Accepted Answer

A)  $369 
B)  $400 
C)  $470 
D)  $500 
A)  $369 
B)  $400 
C)  $470 
D)  $500

Question 8

What is the recovery rate?

Accepted Answer

The recovery rate is the perce

Question 9

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the risk neutral default probability?

Accepted Answer

A)  13.0% 
B)  20.5% 
C)  38.3% 
D)  44.4% 
A)  13.0% 
B)  20.5% 
C)  38.3% 
D)  44.4%

Question 10

The difference between the yield to maturity on a defaultable bond and an otherwise equivalent default-free bind is called the:

Accepted Answer

A)  Credit risk 
B)  Credit spread 
C)  Loss given default 
D)  Recovery rate 
A)  Credit risk 
B)  Credit spread 
C)  Loss given default 
D)  Recovery rate

Question 11

What is meant by the phrase "tranche" when referring to collateralized debt obligations?

Accepted Answer

The process of creating a tranche relate

Question 12

A firm has a single issue of a zero coupon debt that promises to pay $40 in 5 years,and the A₀ = $50,r = 4%,σ = 12%,and δ = 0.If the asset has a 5% chance of total default,what is the value of the debt?

Accepted Answer

A)  $30.83 
B)  $42.68 
C)  $55.21 
D)  $62.41 
A)  $30.83 
B)  $42.68 
C)  $55.21 
D)  $62.41

Question 13

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the recovery rate assuming true default probability?

Accepted Answer

A)  $369 
B)  $400 
C)  $470 
D)  $500 
A)  $369 
B)  $400 
C)  $470 
D)  $500

Question 14

The chance that a counter party may fail to meet a contractual obligation on a debt instrument is referred to as:

Accepted Answer

A)  Credit risk 
B)  Credit spread 
C)  Loss given default 
D)  Recovery rate 
A)  Credit risk 
B)  Credit spread 
C)  Loss given default 
D)  Recovery rate

Question 15

A bond has a current value of $950 and promises to pay $1,000 at the end of 4 years.The expected return on the asset is 12% and the risk free rate is 3%.If the actual cash payout in case of default is 0,what is the risk neutral default probability given that the asset has a standard deviation of 18%?

Accepted Answer

A)  15.2% 
B)  21.5% 
C)  33.2% 
D)  49.6% 
A)  15.2% 
B)  21.5% 
C)  33.2% 
D)  49.6%

Question 16

A bond has a current value of $950 and promises to pay $1,000 at the end of 4 years.The expected return on the asset is 12% and the risk free rate is 3%.If the actual cash payout in case of default is 0,what is the true default probability given that the asset has a standard deviation of 18%?

Accepted Answer

A)  15.2% 
B)  21.5% 
C)  33.2% 
D)  49.6% 
A)  15.2% 
B)  21.5% 
C)  33.2% 
D)  49.6%

Question 17

What are the two ways that the payoff conditional on default can be expressed?

Accepted Answer

The recovery rate is the amoun

Question 18

What does a transition matrix indicate about a bond's future credit risk?

Accepted Answer

A transition matrix tells us t

Exam 27: Credit Risk

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the true default probability?

What is a credit default swap and what function does it serve?

Credit risk has always existed.Since the early 1990s,credit derivatives have become dominant in the capital markets.How do these instruments serve to reduce and/or transfer risk? Can you think of ways in which the existence of credit derivatives has made the financial markets more efficient?

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 4%,σ = 25%,and δ = 0.If the asset has a 2% chance of total default,what is the yield on the bond?

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 4%,σ = 25%,and δ = 0.If the asset has a 2% chance of total default,what is the value of the debt?

A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years,and the A₀ = $100,r = 5%,σ = 15%,and δ = 0.If the asset has no chance of total default,what is the value of the debt?

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the recovery rate assuming risk neutral default probability?

What is the recovery rate?

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the risk neutral default probability?

The difference between the yield to maturity on a defaultable bond and an otherwise equivalent default-free bind is called the:

What is meant by the phrase "tranche" when referring to collateralized debt obligations?

A firm has a single issue of a zero coupon debt that promises to pay $40 in 5 years,and the A₀ = $50,r = 4%,σ = 12%,and δ = 0.If the asset has a 5% chance of total default,what is the value of the debt?

Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the recovery rate assuming true default probability?

The chance that a counter party may fail to meet a contractual obligation on a debt instrument is referred to as:

A bond has a current value of $950 and promises to pay $1,000 at the end of 4 years.The expected return on the asset is 12% and the risk free rate is 3%.If the actual cash payout in case of default is 0,what is the true default probability given that the asset has a standard deviation of 18%?

What are the two ways that the payoff conditional on default can be expressed?

What does a transition matrix indicate about a bond's future credit risk?

Introduction to Derivatives

An Introduction to Forwards and Options

Insurance, collars, and Other Strategies

Introduction to Risk Management

Financial Forwards and Futures

Commodity Forwards and Futures

Interest Rate Forwards and Futures

Swaps

Parity and Other Option Relationships

Binomial Option Pricing: Basic Concepts

Binomial Option Pricing: Selected Topics

The Black-Scholes Formula

Market-Making and Delta-Hedging

Exotic Options: I

Financial Engineering and Security Design

Corporate Applications

Real Options

The Lognormal Distribution

Monte Carlo Valuation

Brownian Motion and Itos Lemma

The Black-Scholes-Merton Equation

Risk-Neutral and Martingale Pricing

Exotic Options: 2

Volatility

Interest Rate and Bond Derivatives

Value at Risk

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