1. Valuation Adjustment Mechanism (VAM), also known as bet-on agreement, is a type of contract commonlyusedinprivateequity investment activities. Aproducerspent0.20billionChineseYuan(CNY)onmakingamovie Warrior Doggie II. The producer then entered into a VAMagreementwithamoviedistributor. According to the VAM, the distributor pays 0.22 billion CNY to the producer and, in return, can retain part of the box office revenue. Specifically, the distributor obtains 12% of the first 0.8 billion CNY of the revenue, 25% of the revenue between 0.8 and1.5 billion CNY, and 15%oftherevenueexceeding 1.5 billion CNY. The distributor then transfers the rest of the box office revenue to the movie producer. For simplicity, assume that the distributors operational cost is zero.

1. Is this VAM a derivative contract? If not, why? If yes, what is the underlier of this contract?

2.What is the minimum profit for the movie producer? What is the maximum loss of the distributor?

When does the distributor break even, i.e. earn zero profit?

4.In previous questions, we assume that no one defaults. Does the producer bear any counter-party credit risk? In other words, will the distributor ever default on the VAM agreement and why?