Topic 22 to 25 Test ID: 8829513

Question #1 of 39 Question ID: 440116

Sammy Smith and Danny Diamond are discussing the analytical techniques for estimating credit portfolio losses. Sammy Smith
makes the following statements. Which of the following statements is(are) correct?

I. Simulation is most useful for estimating default intensity and recovery rates.

II. The correlation between tranches is more important than the correlation at the asset level.

III. The two most important parameters to estimate are default intensity and default correlation.

A) III only.
B) II and III.
C) I and II.
D) I only.

Question #2 of 39 Question ID: 444789

Constructing a hazard rate curve is most similar to:

A) Conducting Bernoulli trials, only.

B) bootstrapping, interpolation, and conducting Bernoulli trials.
C) bootstrapping and interpolation, only.
D) bootstrapping, only.

Question #3 of 39 Question ID: 444788

Which of the following statements is least accurate about a Bernoulli model set up to model default risk for a single company?

A) Each trial of the Bernoulli distribution is conditionally independent.

B) The outcomes of this Bernoulli experiment can only be "default" or "no default".

C) The Bernoulli distribution has a "memoryless" property.

D) The Bernoulli distribution in this exercise will equal the cumulative probability of default.

Question #4 of 39 Question ID: 440096

Under the Merton model, the value of a firm's equity can be described as a:

A) call option on the equity of the firm with an exercise price at the face value of the firm's debt.

1 of 11
 B) call option on the assets of the firm with an exercise price at the face value of the firm's debt.
C) put option on the equity of the firm with an exercise price at the face value of the firm's debt.
D) put option on the assets of the firm with an exercise price at the face value of the firm's debt.

Question #5 of 39 Question ID: 440108

A credit portfolio with 3,000 credit positions has a total value of $3 million. The default probability for each position is 0.5%, the
estimated recovery rate is zero, and the default correlation is 1.0. Using a confidence level of 99%, what is the credit value at
risk (VaR) of the portfolio?

A) $14,850.
B) −$15,000.
C) $29,700.
D) $30,000.

Question #6 of 39 Question ID: 440105

Spread curves may be upward sloping (typical shape) or downward sloping (short-term distress, but decreasing default risk if it
can survive in the short term). Which of the following statements is(are) correct regarding spread curves?

I. Upward-sloping spread curves are flatter in the long term.

II. Downward-sloping spread curves are steeper in the short term.

A) II only.
B) Both I and II.
C) I only.

D) Neither I nor II.

Question #7 of 39 Question ID: 441983

If a credit position has a correlation with the market factor of 0.4, what is the approximate realized market value at the 99%
confidence level?

A) -1.313.
B) -3.684.
C) -0.932.
D) -0.486.

Question #8 of 39 Question ID: 440100

2 of 11
In the context of waiting for a company to default, the rate parameter in the exponential distribution function is known as the
hazard rate. This parameter indicates the rate at which company default will arrive. Given a hazard rate of 0.2, what is the
cumulative PD at time 4?

A) 0.55.
B) 0.20.
C) 0.45.
D) 0.80.

Question #9 of 39 Question ID: 440093

When does a credit loss on market-driven instruments (e.g., swaps and forwards) arise? When market rates move:

A) in your favor and the counterparty defaults.

B) against you and the counterparty defaults.
C) against you.
D) in your favor.

Question #10 of 39 Question ID: 440104

All of the following are advantages for using credit default swap (CDS) to estimate hazard rates except:

A) CDS coverage is large.

B) CDS contracts are marked-to-market.
C) CDS contracts span multiple maturities.
D) CDS contracts are liquid.

Question #11 of 39 Question ID: 440102

If the credit spread associated with the difference between a corporate bond yield over the risk-free rate is 3% and the recovery
rate in the event of default is 80%, the probability of default associated with this bond is closest to:

A) 2.4%.
B) 3.75%.
C) 27%.
D) 15%.

Question #12 of 39 Question ID: 440097

Credit value at risk (VaR) incorporates potential losses at a future date at a given probability. Credit VaR is typically defined in

3 of 11
terms of unexpected loss as:

A) the worst-case portfolio loss at a given level of significance over a specific holding period, minus the
expected loss.

B) the worst-case portfolio loss at a given level of significance over a specific holding period, minus the
loss given default.

C) the worst-case portfolio loss at a given confidence level over a specific holding period, minus the
loss given default.

D) the worst-case portfolio loss at a given confidence level over a specific holding period, minus the
expected loss.

Question #13 of 39 Question ID: 440112

Which of the following statements about structured credit products is(are) correct?

I. Investments in covered bonds are riskier than mortgage-backed securities.

II. It is unlikely to find auto loans in revolving pools.

III. Mortgage-backed securities have high default risk.

A) II only.
B) I only.
C) I and III.

D) II and III.

Question #14 of 39 Question ID: 440117

In a three-tiered waterfall securitization senior and mezzanine investors are satisfied first. The senior tranche traditionally has the
lower coupon and the lower risk profile. If default rates are increasing from low levels, which of the following would most likely be
accurate regarding the change in price and convexity of the different tranches?

I. Equity tranche values would decrease rapidly then moderate with positive convexity.

II. Equity tranche values would decrease rapidly then moderate with negative convexity.

III. Senior tranche values would decrease rapidly then moderate with positive convexity.

IV. Senior tranche values would moderate then decrease rapidly with negative convexity.

A) I and III.
B) I and IV.

C) II and IV.
D) II and III.

Question #15 of 39 Question ID: 440095

4 of 11
Under the Merton model, default takes place if:

A) the value of equity is less than the value of debt at maturity.

B) the market value of assets is less than the market value of debt at any time up until the time of debt
maturity.

C) the market value of equity is less than the market value of debt at any time up until the time of debt
maturity.

D) the value of assets is less than the value of debt at maturity.

Question #16 of 39 Question ID: 440090

Despite their advantages in mitigating credit risk, credit contracts suffer from a number of problems, including transaction costs,
friction, and conflicts of interest issues. Which of the following statements is true regarding risk shifting? Risk shifting:

A) arises when buying insurance or some protection that reduces the incentive of the insured party to
avoid the insured event.

B) occurs when parties to a transaction have asymmetric information.

C) occurs when a group of individuals were to benefit collectively if they all took a course of action, but
would not benefit if an individual alone took the same course of action.

D) occurs when risks and rewards are transferred from one group of market participants to another
group holding different positions in the firm's capital structure.

Question #17 of 39 Question ID: 440092

Assume a credit exposure of $100,000 has a loss given default (LGD) of $22,000 and a recovery rate (RR) is 78%. If the
probability of default (PD) is 1%, what is the expected loss (EL) of this exposure?

A) $780.
B) $1,000.
C) $172.
D) $220.

Question #18 of 39 Question ID: 444790

Who would most likely bear the first loss in a securitization?

A) Originator.
B) Trustee.

C) Underwriter.
D) Credit rating agency.

5 of 11
Question #19 of 39 Question ID: 440088

Types of credit risky securities include corporate and sovereign debt, credit derivatives, and structured credit products. Their
interest rates include a credit spread above credit risk-free securities. Which of the following statements most likely represents
structured credit products?

A) Includes fixed and floating rate bonds issued by corporations and bank loans.
B) Contracts that transfer credit risk and whose payoffs depend on payoffs of other credit risky
securities.

C) Bonds backed by pools of mortgages or loans or some other type of collateral.

D) Debt issued by central, state, provincial or local governments, or state-owned or controlled entities.

Question #20 of 39 Question ID: 440118

Which of the following statements about tranche risk is(are) most likely correct?

I. Increasing granularity at the loan level increases the risk to the senior tranche.

II. Diversified credit pools eliminate systematic risk.

III. Credit card receivable collateral is less granular than mortgage pools.

A) III only.
B) I only.
C) None of the statements are correct.
D) II only.

Question #21 of 39 Question ID: 440114

Which of the following would least likely be associated with an internal credit enhancement for an MBS (Mortgage Backed
Security)?

A) Firm credit enhancement.

B) Overcollateralization.
C) Soft credit enhancement.
D) Excess spread.

Question #22 of 39 Question ID: 440115

With regard to a three-tiered waterfall securitization, how would the excess spread most likely be distributed to the equity
tranche?

A) A coupon amount based on Libor, usually less than the senior tranche.
B) Any residual amount after the accumulation trust is satisfied.

6 of 11
 C) A maximum amount based on an overcollateralization trigger.
D) A coupon amount based on Libor, usually less than the mezzanine tranche.

Question #23 of 39 Question ID: 440098

A credit spread represents the difference in yields between the security of interest and a reference security. Which of the
following spread measure definitions represents the i-spread?

A) Basis points added to each spot rate on a benchmark curve.

B) YTM risky bond minus linearly interpolated YTM on benchmark government bond.
C) YTM risky bond minus YTM benchmark government bond.
D) Fixed spread above current LIBOR needed to price bond correctly.

Question #24 of 39 Question ID: 439272

In the S&P credit rating scheme, the least risky speculative investment rating is:

A) Aaa.
B) AAA.
C) BB.

D) Ba.

Question #25 of 39 Question ID: 439271

In S&P's credit rating scheme, one investment grade rating is:

A) BB.
B) B.
C) BBB.
D) C.

Question #26 of 39 Question ID: 444792

Which of the following statements is least accurate as it applies to structured credit products?

A) Loan originators collect the service fees of securitizations.

B) Investors would not have access to certain types of loans without securitizations.
C) Senior tranches are designed to offer lower risk-return levels than equity tranches.
D) Securitizations allow banks to get loans off their balance sheet but at a higher funding cost.

7 of 11
Question #27 of 39 Question ID: 440111

When the copula approach is used to estimate credit VaR, which of the following statements indicates the most common
approach?

A) Defines a copula function using the Poisson distribution.

B) Determines the default loss by summing all of the event outcome terminal values.
C) Maps simulated values to their standard univariate normal quantile.
D) Sets the default threshold at -2.33 for a 99% confidence level.

Question #28 of 39 Question ID: 440106

How many of the following statements about spread volatility are correct?

I. Spread volatility is the historical or expectational variance of spread changes.

II. Mark-to-market calculations shift the entire CDS curve up and down one basis point in each direction.

III. Spread changes incorporate the effect of risk-free interest rate movements.

A) 3 statements are correct.

B) 1 statement is correct.
C) No statements are correct.

D) 2 statements are correct.

Question #29 of 39 Question ID: 440119

Which of the following statements regarding motivations for using structured credit products is least accurate?

A) They provide lower cost of funding for loan originators.

B) They provide a single risk-return option for investors.
C) They provide additional income from servicing fees for loan originators.
D) They increase access for investors looking for diversified loan pools.

Question #30 of 39 Question ID: 440091

Exposure at default (i.e., exposure) is the amount of money the lender can lose in the event of a borrower's default. Which of the
following formulas correctly computes exposure?

8 of 11
 A) exposure = recovery rate / recovery.
B) exposure = recovery + loss given default.
C) exposure = loss given default - recovery.
D) exposure = recovery / loss given default.

Question #31 of 39 Question ID: 440103

The credit spread on a one-year BBB-rated corporate bond relative to the maturity-matched T-bill is 3.5%. Given a recovery rate
in the event of default of 65%, what is the hazard rate for this corporate bond?

A) 10.0%.
B) 2.3%.
C) 18.6%.
D) 5.4%.

Question #32 of 39 Question ID: 440113

With which of the following structured products would the investor most likely receive cash flows based on the performance of the
underlying assets?

I. Covered bonds

II. Mortgage pass-through securities (MBSs)

III. Collateralized mortgage obligations (CMOs)

IV. Structured credit products

A) II, III, and IV.

B) I, II, III, and IV.
C) I, III, and IV.
D) II and III.

Question #33 of 39 Question ID: 444791

The behavior of default sensitivities for tranches are most similar to:

A) low deltas for out of the money options.

B) high deltas for out of the money options.
C) low gammas for at the money options.
D) high gammas for at the money options.

9 of 11
Question #34 of 39 Question ID: 440109

Assuming a specific value for the market parameter, which of the following is an implication of the single-factor model for
assessing the impact of varying default correlations based on a credit position's beta?

A) As the market factor goes from weak to strong economies, a smaller idiosyncratic shock will trigger
default.

B) Individual asset returns and idiosyncratic shocks are not independent from other firm's shocks and
returns.

C) The unconditional standard deviation of 1 > the conditional standard deviation [√(1 - β2)].
D) If the market parameter and beta have values that do not equal one, then the conditional probability
of default will be greater than the unconditional probability of default .

Question #35 of 39 Question ID: 440089

The components of the economic balance sheet include assets that are financed by debt and equity. Which of the following ratios
correctly identifies the leverage ratio?

A) Ratio of debt over assets.

B) Ratio of debt over equity.
C) Ratio of assets over equity.

D) Ratio of book value over market value.

Question #36 of 39 Question ID: 440101

A loan of $13m is made to a counterparty whose expected default rate is 3% per annum and expected recovery rate is 35%.
Assuming an all in cost of funds of LIBOR for the lender, what would be the fair price for the loan?

A) 105 basis points.

B) 150 basis points.
C) 300 basis points.
D) 195 basis points.

Question #37 of 39 Question ID: 440107

Jared Pitino has decided that his firm should begin using the correlation-based credit portfolio framework. However, a junior
employee provides Pitino a list of drawbacks regarding this method. Which of the following statements in the list is least
accurate?

A) A multiple firm framework will require a large amount of required calculations.

B) Technical factors are not accounted for in this method.
C) Contingent liabilities are unable to be accurately modeled using this method.

10 of 11
 D) The excessive amount of historical data for default correlations makes it difficult to draw accurate
conclusions.

Question #38 of 39 Question ID: 442246

Assume that the current z-spread is 207 bps for a bond that is priced at $93. When the z-spread is increased by 0.5 basis points
to 207.5 bps, the new bond price is $92.91 and when the z-spread tightens by 0.5 basis points to 206.5 bps, the bond price
increases to $93.16. Hence, given a $100 par value, the spread '01 measure is:

A) 0.93 dollars per basis point.

B) 0.09 dollars per basis point.
C) 0.16 dollars per basis point.
D) 0.25 dollars per basis point.

Question #39 of 39 Question ID: 440094

Double default risk measures the risk that:

A) a counterparty is unable to fulfill its contractual obligations while at the same it is unable to net its
outstanding exposures.
B) an entity simultaneously defaults on two of its payment obligations.
C) a counterparty that sold third party default protection will default at the same time as the third party.

D) both counterparties to a transaction default simultaneously.

11 of 11