SECTION B - Answer ALL Questions Question 1 Consider a 5-year bond with a face value of $100 that pays an annual coupon of 6% and is currently rated BBB. The expected recovery rate in case of default is 51.13%. In the table below, you are given the probabilities that in one year (i) the bond issuer maintains its BBB rating, (ii) is upgraded to AAA, AA or A or downgraded to BB, B or CCC and (iii) defaults. Rating Probability (%) AAA 002 AA 0.33 A 5.95 BBB 86.93 BB 5.3 B 117 CCC 012 Default 018 Consider also the one-year forward yield curve for zero-coupon bonds with different maturities and credit ratings (rates are discretely compounded): Years to Maturity Rating 1 year 2 years 3 years 4 years AAA 3.60% 4.17% 4.73% 5.12% AA 3.65% 4.22% 4.78% 5.17% A 3.72% 4.32% 4.93% 5.32% BBB 4.10% 4.67% 5.25% 5.63% BB 5.55% 6.02% 6.78% 7.27% B 6.05% 7.02% 8.03% 8.52% CCC 15.05% 15.02% 14.03% 13.52% See Next Page Page 3 of 5 7SSMM707 a) Compute the volatility of the above bond in one year. b) is the volatility a coherent risk measure? Explain. c) Compute the 1-year Value-at-Risk and Expected Shortfall of the above bond at a 99% confidence level. [25 marks] SECTION B - Answer ALL Questions Question 1 Consider a 5-year bond with a face value of $100 that pays an annual coupon of 6% and is currently rated BBB. The expected recovery rate in case of default is 51.13%. In the table below, you are given the probabilities that in one year (i) the bond issuer maintains its BBB rating, (ii) is upgraded to AAA, AA or A or downgraded to BB, B or CCC and (iii) defaults. Rating Probability (%) AAA 002 AA 0.33 A 5.95 BBB 86.93 BB 5.3 B 117 CCC 012 Default 018 Consider also the one-year forward yield curve for zero-coupon bonds with different maturities and credit ratings (rates are discretely compounded): Years to Maturity Rating 1 year 2 years 3 years 4 years AAA 3.60% 4.17% 4.73% 5.12% AA 3.65% 4.22% 4.78% 5.17% A 3.72% 4.32% 4.93% 5.32% BBB 4.10% 4.67% 5.25% 5.63% BB 5.55% 6.02% 6.78% 7.27% B 6.05% 7.02% 8.03% 8.52% CCC 15.05% 15.02% 14.03% 13.52% See Next Page Page 3 of 5 7SSMM707 a) Compute the volatility of the above bond in one year. b) is the volatility a coherent risk measure? Explain. c) Compute the 1-year Value-at-Risk and Expected Shortfall of the above bond at a 99% confidence level. [25 marks]