Hull:Options,Futures,andOtherDerivatives,NinthEditionChapter24:CreditRiskMultipleChoiceTestBank:QuestionswithAnswers1.Supposethatthecumulativeprobabilityofacompanydefaultingbyyearsone,two,threeandfourare3%,6.5%,10%,and14.5%,respectively.Whatistheprobabilityofdefaultinthefourthyearconditionalonnoearlierdefault?A.4.5%B.5.0%C.5.5%D.6.0%Answer:BTheunconditionalPDforthefourthyearis14.5%minus10%or4.5%.Theprobabilityofnoearlierdefaultis90%.ThePDconditionalonnoearlierdefaultistherefore0.045/0.9=0.05or5%2.Whichofthefollowingisusuallyusedtodefinetherecoveryrateofabond?A.ThevalueofthebondimmediatelyafterdefaultasapercentofitsfacevalueB.Thevalueofthebondimmediatelyafterdefaultasapercentofthesumofthebond’sfacevalueandaccruedinterestC.TheamountfinallyrealizedbyabondholderasapercentoffacevalueD.Theamountfinallyrealizedbyabondholderasapercentofthesumofthebond’sfacevalueandaccruedinterestAnswer:ATherecoveryrateforabondisusuallydefinedasthevalueofthebondimmediatelyafteradefaultasapercentofitsfacevalue.Thisisinspiteofthefactthatthebondholder’sclaimintheeventofadefaultinmanyjurisdictionsisthefacevalueplusaccruedinterest.3.Whichofthefollowingistrue?A.RiskneutraldefaultprobabilitiesareusuallymuchlowerthanrealworlddefaultprobabilitiesB.RiskneutraldefaultprobabilitiesareusuallymuchhigherthanrealworlddefaultprobabilitiesC.RiskneutralandrealworldprobabilitiesmustbeclosetoeachotheriftherearetobenoarbitrageopportunitiesD.Risk-neutraldefaultprobabilitiescannotbecalculatedfromCDSspreadsAnswer:BRiskneutraldefaultprobabilitiesareusuallygreaterthanrealworlddefaultprobabilities.4.Ahazardrateis1%perannum.Whatistheprobabilityofadefaultduringthefirsttwoyears?A.2.00%B.2.02%C.1.98%D.1.96%Answer:CTheprobabilityofnodefaultise−0.01×2=0.9802.Theprobabilityofdefaultisoneminusthisor0.0198(i.e.,1.98%).5.WhichofthefollowingistrueA.ThedefaultprobabilityperyearforacompanyalwaysincreasesaswelookfurtheraheadB.ThedefaultprobabilityperyearforacompanyalwaysdecreasesaswelookfurtheraheadC.SometimesAistrueandsomet...
