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Assignment 2 Answer Key

This document contains an assignment with multiple questions regarding market and credit risk management. It includes questions about calculating Value at Risk (VaR) and Expected Shortfall (ES) for a portfolio, estimating hazard rates and default probabilities for bonds using yield spreads and recovery rates, and pricing options issued by banks. The assignment is due on June 23, 2023 and provides space for answers to be written in below each question.

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44 views

Assignment 2 Answer Key

This document contains an assignment with multiple questions regarding market and credit risk management. It includes questions about calculating Value at Risk (VaR) and Expected Shortfall (ES) for a portfolio, estimating hazard rates and default probabilities for bonds using yield spreads and recovery rates, and pricing options issued by banks. The assignment is due on June 23, 2023 and provides space for answers to be written in below each question.

Uploaded by

姜越
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Managing Market and Credit Risks – Spring 2023 Assignment 2

Due date: June 23, 2023

1. (Question 12.12) The change in the value of a portfolio in one month is normally distributed with
a mean of zero and a standard deviation of $2 million. Calculate the VaR and ES for a confidence level
of 98% and a time horizon of three months.
Answer:

2. (Question 12.13) Suppose that each of two investments has a 4% chance of a loss of $10 million,
a 2% chance of a loss of $1 million, and a 94% chance of a profit of $1 million. They are independent of
each other.
(a) What is the VaR for one of the investments when the confidence level is 95%?
(b) What is the expected shortfall when the confidence level is 95%?
(c) What is the VaR for a portfolio consisting of the two investments when the confidence level is
95%?
(d) What is the expected shortfall for a portfolio consisting of the two investments when the confidence
level is 95%?
(e) Show that, in this example, VaR does not satisfy the subadditivity condition whereas expected
shortfall does.
Answer:

3. (Question 12.14) Suppose that daily changes for a portfolio have first-order correlation
√ with
correlation parameter 0.12. The 10-day VaR, calculated by multiplying the one-day VaR by 10, is $2
million. What is a better estimate of the VaR that takes account of autocorrelation?
Answer:

4. (Question 19.4) Calculate the average hazard rate for a Ba-rated company during the third year
from the data in Table 19.1.
Answer:

5. (Question 19.10) The spread between the yield on a five-year bond issued by a company and the
yield on a similar risk-free bond is 80 basis points. Assuming a recovery rate of 40%, estimate the average
hazard rate per year over the five-year period. If the spread is 70 basis points for a three-year bond,
what do your results indicate about the average hazard rate in years 4 and 5?
Answer:

6. (Question 19.14) A four-year corporate bond provides a coupon of 4% per year payable semi-
annually and has a yield of 5% expressed with continuous compounding. The risk-free yield curve is
flat at 3% with continuous compounding. Assume that defaults can take place at the end of each year
(immediately before a coupon or principal payment) and the recovery rate is 30%. Estimate the risk-
neutral default probability on the assumption that it is the same each year using the approach in Table
19.3.
Answer:

7. (Question 19.24) A company has issued one- and two-year bonds providing 8% coupons, payable
annually. The yields on the bonds (expressed with continuous compounding) are 6.0% and 6.6%, respec-
tively. Risk-free rates are 4.5% for all maturities. The recovery rate is 35%. Defaults can take place
halfway through each year. Estimate the risk-neutral default rate each year.
Answer:

1
8. (Question 20.16) Suppose that the spread between the yield on a three-year risk less zero-coupon
bond and a three-year zero-coupon bond issued by a bank is 210 basis points. The Black–Scholes–Merton
price of an option is $4.10. How much should you be prepared to pay for it if you buy it from a bank?
Answer:

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