Question 1(20 marks) A Financial Institution has an AA-rated 4-year senior unsecured zero-coupon bond with face value $1 million and current yield 3.5%. The Financial Institution has estimated the one-year transition matrix as in Table 1, the current one-year forward zero curves as in Table 2, and the recovery rates as in Table 3. (20 marks) Using the CreditMetrics model, what is the 1-year 99% Credit VaR of this single bond? Table 1: One-year Transition Matrix (%) Rating at year-end (%) Initial Rating AAA AA A BBB BB B CCC Default AAA 90.01 6.32 2.59 0.84 0.22 0.02 0.00 0.00 AA 1.11 88.15 7.60 2.86 0.25 0.02 0.01 0.00 A 0.52 1.32 83.39 10.29 3.46 0.36 0.04 0.62 BBB 0.17 0.66 1.37 85.16 8.75 2.85 0.28 0.76 BB 0.07 0.32 0.58 1.25 79.75 9.92 3.30 4.81 B 0.00 0.06 0.21 0.65 1.42 74.25 9.15 14.26 CCC 0.00 0.00 0.06 0.23 0.722.76 71.81 24.42 Table 2: One-year Forward Zero Curves by Credit Rating Categories (%) Year 1 Year 2 Year 3 Category AAA 3.45 3.77 4.13 AA 3.53 3.80 4.24 A 3.71 4.01 4.44 BBB 3.88 4.18 4.59 BB 4.02 4.31 4.67 B 4.21 4.46 4.92 CCC 4.44 4.09 5.06 Table 3: Recovery Rate by Seniority Class (% of Face Value) Seniority Class Mean (%) Standard Deviation (%) Senior Secured 59.23 33.46 Senior Unsecured 51.42 27.05 Senior Subordinated 43.71 23.60 Subordinated 29.94 21.12 Junior Subordinated 11.74 12.60