Question
Next two questions are based on the information given below : An investor, Jack, holds a two year fixed rate bond of $100 million from
Next two questions are based on the information given below : An investor, Jack, holds a two year fixed rate bond of $100 million from a company and the bonds rating is B. The bond coupon rate is 6%. The following table 1 represents the credit matrix, which shows the historical credit risk migration in one year. Table 2 shows the different discount rate of three types of the bond. Also, loss given default rate is 60%. Based on the information of the bond, answer question 5 and 6.
Table 1.
A | B | C | Default | |
B | 2% | 97% | 0.8% | 0% |
Table 2
Discount Rate Table | |
A | 4% |
B | 5% |
C | 8% |
Default | 7% |
1. Jack wants to estimate the expected price of the bond next year. He knows that if the bond is upgraded to A, the price would be 6 + 106 / 1.04 = 107.923. He knows that if the bond is downgraded to C, the price would be 6 + 106 / 1.08 = 104.148. Now, Jack wants you to help him finish the calculation in different scenarios and get the estimated price of the bond next year. Table 3 can be used to estimate the expected price next year (Round Numbers to Three Decimal Places)
A. 106.82
B. 106.83
C. 106.88
D. 108.91
Table 3.
Original Bond Rating B | A | B | C | Default |
Value | 107.923 | 104.148 | ||
Probability | 2% | 97% | 0.80% | 0.20% |
Expected Value | ||||
Probability * (Value - Expected Value) ^2 |
2. Based on your calculation, Jack further estimates the standard deviaiton. He now has 99% confidence that the bond value would not be lower than which of the following value next year? (Assume that there is 98% chance that observations lie between 2.33 and -2.33 standard deviations from the mean.)
A. 83.81
B. 68.22
C. 100.07
D. 16.6
3. The dark side of retail risk is perpetuated by all of the following factors except:
A. capital set aside to protect a bank in the event of default
B. process flaws resulting in high risk applicants receiving credit
C. new products which do not have sufficient historical loss data
D. a social acceptance of bankruptcy and borrowers "walking away" from their obligations
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