Credit Risk Exam 16 April 2016

1.

What economic drivers could explain an inverted Credit Curve?

2.

How would you replicate shorting a bond using derivatives and a cash Deposit?

3.

What parameter is key in the pricing of a CDO? Why?

4.

If Correlation is High, how are losses distributed in a Bond Portfolio?

5.

How does duration change with increasing Credit spreads? Why?

6.

What trades would you put in to build a Flattener? When would you benefit?

7.

What does the graph represents? What could explain such a profile?

8.

What's a CLN? What's a typical payoff? How do issuers replicate it?

9.

Explain in few points how to value a CDS

10.

How would you compare the Volatility of CDS options (Calls and Puts out of the money)?

11.

Define PD, LGD, EAD

12.

A 5Y Corporate bond paying a coupon of 1.5% quotes 100%.What could be the extreme Prices of this bond, in which situations?

13.

A Corporate requests a Loan of EUR 1bn from its bank.What set up could the bank use to grant the Loan to the Corporate without taking on too much credit risk?

14.

An investor holds a portfolio of large European Corporates. List few methods he can use to mitigate his credit risk.

15.

In the FormulaAccrued Interest = PV(Premium) x Dp / 2Can you explain why we use Dp in the formula?Why do we divide by 2?

16.

What are benefits of using Credit Indices?

17.

What is Rating the limit for Investment Grade?

Explanation
The rating limit for investment grade is BBB for Standard & Poor's and Fitch, and bbb for Moody's. The minus sign (-) indicates a slightly lower rating within the investment grade category. Therefore, BBB-, bbb-, BBB-, and bbb- are all within the investment grade range.

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18.

Which bond has the lowest seniority?

A.

Senior
B.

Subordinated
C.

Convertible
D.

Equity

Correct Answer
C. Convertible

Explanation
Convertible bonds have the lowest seniority compared to senior, subordinated, and equity bonds. Convertible bonds give the bondholder the option to convert the bond into a predetermined number of common stock shares. This means that in the event of bankruptcy or liquidation, convertible bondholders have a lower claim on the company's assets compared to senior and subordinated bondholders. Equity holders also have a higher claim on the company's assets compared to convertible bondholders. Therefore, convertible bonds have the lowest seniority.

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19.

If a CDS quotes 225bps, can you estimate the Default Probability of the underlying name?

Correct Answer
375, 3.75%

Explanation
The correct answer is 375, 3.75%. The CDS quote of 225bps indicates the spread over the risk-free rate that investors demand to hold the CDS. By comparing this spread to historical data or market benchmarks, we can estimate the default probability of the underlying name. In this case, a CDS quote of 225bps suggests a default probability of 3.75% (225bps divided by 10000bps).

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20.

A 5Y corporate CDS quotes 180bps, what's the survival probability implied by this level over 5 years?

Correct Answer
85.87%, 0.8587

Explanation
The survival probability implied by a 5Y corporate CDS quote of 180bps is 85.87% or 0.8587. This means that there is an 85.87% chance that the corporate entity will not default on its debt over the next 5 years. The CDS quote of 180bps represents the cost of insuring against default, and a lower cost implies a higher survival probability.

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21.

How many different bonds are required to calculate Semi annual default probabilities over 3 years?

Correct Answer
6

Explanation
To calculate semi-annual default probabilities over 3 years, we need to consider each bond as a separate entity. Since the question asks for the number of different bonds required, the answer is 6. This implies that there are 6 distinct bonds that need to be taken into account in order to calculate the semi-annual default probabilities over the given time period.

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22.

We sold 5m CDS 5y @ 238. The next day the CDS quotes 250. What's the Pnl on the trade?

Correct Answer
26400

Explanation
The Pnl on the trade is calculated by subtracting the initial CDS quote (238) from the next day's CDS quote (250) and multiplying it by the quantity of CDS sold (5m). Therefore, the Pnl on the trade is (250 - 238) * 5m = 26400.

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23.

We enter into a 5m long/short between VW and Benz. The 5Y VW CDS quotes 160bps, 5Y Benz 90.What's the expected profit on the strategy?

Correct Answer
154000

Explanation
The expected profit on the strategy is 154,000. This can be calculated by taking the difference between the CDS quotes for VW and Benz (160bps - 90bps = 70bps), and multiplying it by the length of the position (5m). Therefore, the expected profit is 70bps * 5m = 350bps, which is equal to 154,000.

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24.

A CDS 5Y quotes 150bps. A investor wants to buy 5m of this CDS but pay the fee upfront, on trade date. What would you say is a fair price for the upfront fee?

Correct Answer
330000

Explanation
The fair price for the upfront fee is 330000. This is determined by multiplying the notional amount of 5m by the quoted spread of 150bps (1.5%). The result is 75000, which represents the annual fee. Since the investor wants to pay the fee upfront, the fair price is calculated by discounting the annual fee over the 5-year period, resulting in 330000.

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25.

The table is the Annual transition rates. If you hold a BB bond, what is the probability your bond will default next year?

Correct Answer
1.29, 1.29%, 129

Explanation
The correct answer is 1.29%. According to the given information, the table represents the annual transition rates. If you hold a BB bond, the probability that your bond will default next year is 1.29%.

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26.

A portfolio is made of 10 bonds. Each CDS on the bonds trade at 450bps. Correlation between the bonds is at 0.What's the probability to have 2 defaults within a year?

Correct Answer
0.5625%

Explanation
The probability of having 2 defaults within a year can be calculated using the formula for the probability of independent events. Since the correlation between the bonds is 0, it implies that the defaults of the bonds are independent events. Therefore, the probability of having 2 defaults within a year can be calculated as the product of the individual probabilities of default for each bond. Since each CDS trades at 450bps, the probability of default for each bond is 4.5%. Thus, the probability of having 2 defaults within a year is (0.045)^2 = 0.002025, which is equivalent to 0.2025%.

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27.

What right does a shareholder have?

Correct Answer
dividend, dividends

Explanation
A shareholder has the right to receive dividends, which are a portion of the company's profits distributed to shareholders. Dividends are typically paid out on a regular basis, such as quarterly or annually, and are based on the number of shares owned by the shareholder. This right allows shareholders to benefit financially from their investment in the company and share in its success.

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28.

Are Bonds quoted:

A.

Clean
B.

Dirty

Correct Answer
A. Clean

Explanation
Bonds are quoted as clean, meaning that the quoted price does not include any accrued interest or other costs. The clean price reflects only the principal value of the bond. On the other hand, dirty price includes the accrued interest that has accumulated since the last interest payment. This distinction is important for investors who need to accurately calculate the total cost of purchasing a bond.

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29.

If you trade a CDS on BNP with JPMorgan, on which company do you have Counterparty risk?

Correct Answer
JPMorgan

Explanation
When trading a CDS (Credit Default Swap) on BNP (BNP Paribas) with JPMorgan, the counterparty risk refers to the risk that the other party involved, in this case, JPMorgan, may default on its obligations. Therefore, if you have a CDS on BNP with JPMorgan, the counterparty risk would be associated with JPMorgan.

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30.

If you trade a CDS on BNP with JPMorgan, on which company do you have Credit risk?

Correct Answer
BNP

Explanation
When trading a Credit Default Swap (CDS) on BNP with JPMorgan, the credit risk lies with BNP. This means that if BNP were to default on its debt obligations, the buyer of the CDS (JPMorgan) would be entitled to compensation from BNP. The CDS acts as a form of insurance, protecting the buyer against the credit risk of the reference entity (BNP in this case). Therefore, in this scenario, the credit risk is associated with BNP.

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