Deck 27: Credit Risk

Question 1

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

Answer 1

D

Question 2

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

Answer 2

The process of creating a tranche relates to dividing the cash flows from debt into different categories.Relative to CDOs,it means to place a different priority,with respect to cash flows,on each of the different categories.

Question 3

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

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

Answer 3

B

Question 4

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?

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

Question 5

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?

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

Question 6

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?

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

Question 7

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

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

Question 8

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

Question 9

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?

Question 10

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?

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

Question 11

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%?

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

Question 12

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?

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

Question 13

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%?

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

Question 14

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

Question 15

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

Question 16

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?

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

Question 17

What is the recovery rate?

Question 18

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