Corporate Risk Management: Exam Essay Example

Morton default model we determine that the risk-neutral probability of fault for a bond with a maturity of 6 years is 35% and the expected recovery rate is 50%.

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Corresponding 1, 6, and 30 year Treasury yields are 1, 2, and 3%, respectively. What is the theoretical credit spread? (7 points) suppose you nave a Portola consisting AT Just 2 Donnas, one rate A Ana ten toner B. The characteristics of both bonds are as indicated in the table below. A-rated Bond Year-end Rating Value ($) Probability (%) 125 115 75 a-rated Bond 8 2 120 5 85 10 For the 2 bond portfolio what is the probability that both bonds are a-rated next period? What is the portfolios value? 7 Points) Show work for full credit.

6. You have a $1 B pool of assets with which you wish to create a collateralized default obligation. There are three trenches; a senior, mezzanine and Junior trance. The senior trance is 85% of the pool, and the mezzanine is 10% and Junior trance is 5% of the pool. There are 4 possible default outcomes; as indicated below: Default Scenario Probability 20 . 10 3 4 . 01 The loss severity for each scenario is 50% and the risk-free rate is 4%. A. What is the level of subordination of the senior trance (that is as a percent of the total pool)? What does this mean? (7 Points) b. Compute the payoffs and losses for each trance for scenario 4 using the table below for your answers (7 Points) Senior Mezzanine Junior Loss Payoff a. Compute the price and

yield for the Junior trance. (7 Points) / Assume you nave a S pool AT assets Tanat you own Ana you nave determined that the pool could face one of two scenarios. Scenario 1 has a 20% chance of occurring that will lead to a probability of default of 13. 3%, or scenario 2 that has an 80% chance of happening leading too probability of default of The covers rate on the pool is 70% under scenario 1 and 80% under scenario