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16. Suppose a 20-year annual coupon bond has a DV01 of 0.14865. Also suppose a 12-year annual coupon bond, which will be used as the hedging instrument, has a DV01 of 0.09764. If the yield beta is 1.10, which of the following statements accurately describes the situation?
A. The hedging instrument is significantly more volatile than the position in the 20-year bond, and the hedge ratio is 1.67467.
B. The position in the 20-year bond is significantly more volatile than the hedging instrument, and the hedge ratio is 0.72253.
C. In order to have a perfectly hedged position, for every USD 1 of the 20-year bond, USD 1.67467 of the 12-year bond should be shorted.
D. In order to have a perfectly hedged position, for every USD 1 of the 20-year bond, USD 0.72253 of the 12-year bond should be shorted.
Correct answer is Cffice ffice" />
A is incorrect. While the calculated hedge ratio is correct, its interpretation is incorrect.
B is incorrect. Hedge ratio has been incorrectly calculated with the DV01 of hedging instrument in the numerator and DV01 of the position in the denominator (whereas it should be the other way).
C is correct.
Hedge Ratio = (0.14865 x 1.10) / 0.09764 = 1.674672.
Interpretation in answer 'C' is accurate for hedge ratio.
D is incorrect. Because the calculated hedge ratio is incorrect.
Reference: Bruce Tuckman, Chapter 5.
17. Suppose Bank A sells exposure in a mortgage portfolio to Bank B. In order to determine the credit risk of such a transaction, all of the following must be taken into account except
A. Probability of default of the mortgage portfolio.
B. Probability of default of Bank B.
C. Correlation between the default of Bank B and the mortgage portfolio.
D. Correlation between Bank A and Bank B.
Correct answer is D
A is incorrect. The probability of default by both the counterparty (Bank B) and the underlying asset (mortgage portfolio) depends on the marginal probability of either and the correlation between the two.
B is incorrect. The probability of default by both the counterparty (Bank B) and the underlying asset (mortgage portfolio) depends on the marginal probability of either and the correlation between the two.
C is incorrect. The probability of default by both the counterparty (Bank B) and the underlying asset (mortgage portfolio) depends on the marginal probability of either and the correlation between the two.
D is correct. While there may be (and is likely some) degree of correlation between the two Banks, this correlation is irrelevant to the probability of default of the counterparty and underlying asset portfolio.
18. Which of the following statements about credit risk models is most accurate?
A. KMV models offer a structural approach to measuring credit risk that is based on credit migration.
B. CreditRisk+ models offer an actuarial approach to measuring credit risk that treats the bankruptcy and recovery processes as endogenous.
C. KMV models are an extension of Merton's Option Pricing Model employing equity price volatility as a proxy for asset price volatility.
D. CreditRisk+ models, like the reduced-form models, use a chi-square distribution to describe default.
Correct answer is C
A is incorrect. KMV models are NOT based on credit migration.
B is incorrect. In CreditRisk+ models, the bankruptcy/recovery processes are exogenous.
C is correct. KMV models employ equity price volatility as a proxy for asset price volatility.
D is incorrect. CreditRisk+ models use a Poisson or Poisson-like distribution to describe default.
Reference: Amaud de Servigny and Olivier Renault, Chapter 6, Credit Risk Portfolio Models.
19. Assume Satya Bank, having a capital of USD 500 million, wants to limit its losses in the energy sector to 6% and in the construction sector to 4.5% of its capital. The LGD rates for the energy and construction sectors are, respectively, 45% and 70%. If Satya Bank wants to strictly adhere to its concentration limit policy, the maximum permitted loan amount to the energy and construction sectors will be:
A. Energy = USD 66.7 million Construction = USD 32.1 million
B. Energy = USD 13.5 million Construction = USD 15.8 million
C. Energy = USD 37.5 million Construction = USD77.8 million
D. Energy = USD 30.0 million Construction = USD 22.5 million
Correct answer is A
A is correct.
Concentration Limit = Capital x (loss limit on capital / loss rate of the sector)
Concentration Limit for Energy = USD 500 million x (0.06 / 0.45) = USD 66,666,667
Concentration Limit for Constr. = USD 500 million x (0.045 / 0.70) = USD 32,142,857
B is incorrect. It uses incorrect variables and/or formula to calculate concentration limits.
C is incorrect. It uses incorrect variables and/or formula to calculate concentration limits.
D is incorrect. It uses incorrect variables and/or formula to calculate concentration limits.
20. A bank credit officer, who has reviewed a loan application, has made the following statement:
"On a stand alone basis, I was not very keen on granting this loan however, I granted this loan after looking at the overall asset portfolio of the bank." Based on the above statement, which of the following is true.
A. The correlation of the newly granted loan with the overall portfolio is low and therefore the credit officer was right in granting the loan.
B. The correlation of the newly granted loan with the overall portfolio is low and therefore the credit officer was wrong in granting the loan.
C. The correlation of the newly granted loan with the overall portfolio is high and therefore the credit officer was right in granting the loan.
D. The correlation of the newly granted loan with the overall portfolio is high and therefore the credit officer was wrong in granting the loan.
Correct answer is A
A is Correct. The risk of a loan at the portfolio level is guided by both its systematic risk and unsystematic risk. Therefore low correlation of the new loan with the overall existing portfolio make it better investment decision due to diversifications benefits. Therefore, the credit officer was right in his reasoning.
B is Incorrect as explained in A.
C is Incorrect as explained in A.
D is Incorrect as explained in A.
Reference: Saunders? Chapter 16 | 
发表于 2009-6-13 14:45
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