121. Bank A has exposure to USD 100 million of debt issued by Company R. Bank A enters into a credit default swap transaction with Bank B to hedge its debt exposure to Company R. Bank B would fully compensate Bank A if Company R defaults in exchange for premium. Assume that the defaults of Bank A, Bank B, and Company R are independent and that their default probabilities are 0.3%, 0.5%, and 3.6%, respectively. What is the probability that Bank A will suffer a credit loss in its exposure to Company R?

a.       4.1%

b.       3.6%

c.       0.0108%

d.       0.0180%

122. A fund manager recently received a report on the performance of his portfolio over the last year. According to the report, the portfolio return is 9.3%, with a standard deviation of 13.5%, and beta of 0.83. The risk-free rate is 3.2%, the semi-standard deviation of portfolio is 8.4%, and the tracking error of the portfolio to the benchmark index is 2.8%. What is the difference between the value of the fund’s Sortino ratio (computed relative to the risk-free rate) and its Sharpe ratio?

a.       1.727

b.       0.274

c.       -0.378

d.       0.653

123. Your company is expecting a major export order from a London-based client. The receivables under the contract are to be billed in GBP, while your reporting currency is USD. Since the order is a large sum, your company does not want to bear the exchange risk and wishes to hedge it using derivatives. To minimize the cost of hedging, which of the following is the most suitable contract?

a.       A chooser option for GBP/USD pair

b.       A cross-currency swap where you pay fixed in USD and receive floating in GBP

c.       A barrier put option to sell GBP against USD

d.       An Asian call option on GBP against USD

124. A bond trader has bought a position in Treasury bonds with a 4% annual coupon rate on February 15, 2015. The DV01 of the position is USD 80,000. The trader decides to hedge his interest rate risk with the 4.5% coupon rate Treasury bonds maturing on May 15, 2017, which has a DV01 of 0.076 per USD 100 face value. To implement this hedge, approximately what face amount of the 4.5% Treasury bonds maturing on May 15, 2017, should the trader sell?

a.       USD 10,500,000

b.       USD 80,000

c.       USD 105,000,000

d.       USD 80,000,000

125. The bank you work for has a RAROC model. The RAROC model, computed for each specific activity, measures the ratio of the expected yearly net income to the yearly VaR risk estimate. You are asked to estimate the RAROC of its USD 500 million loan business. The average interest rate is 10%. All loans have the same probability of default of 2% with a loss given default of 50%. Operating costs are USD 10 million. The funding cost of the business is USD 30 million. RAROC is estimated using a credit-VaR for loan businesses. In this case, the appropriate credit-VaR for the loans is 7.5%. The economic capital is invested and earns 6%. The RAROC is:

a.       19.33%

b.       46.00%

c.       32.67%

d.       13.33%