Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 24: Credit Risk Multiple Choice Test ank: !uestions 1. Suppose that the cumulative probability probability of a company company defaulting defaulting by years one, two, three three and four are are 3%, 6.5%, 10%, and 1.5%, respectively. respectively. !hat is the probability of default in the fourth year conditional on no earlier default" #. .5% $. 5.0% . 5.5% &. 6.0% '. !hich of the following following is usually usually used used to de(ne the recovery recovery rate of of a bond" #. )he value of of the bond immediately after after default as a percent percent of its face value $. )he value of of the bond immediately after after default as a percent percent of the the sum of the bond*s face value and accrued interest . )he amount (nally reali+ed reali+ed by a bondholder bondholder as a percent of of face value value &. )he amount (nally (nally reali+ed by a bondholder bondholder as a percent percent of the sum sum of the bond*s face value and accrued interest 3. !hich !hich of the following following is true" true" #. is- neutral neutral default probabilities probabilities are are usually much lower than real real world default probabilities $. is- neutral neutral default probabilities probabilities are are usually much higher than real real world default probabilities . is- neutral neutral and real real world probabilities probabilities must be close to each other other if there are to be no arbitrage opportunities &. is-neutral default probabilities probabilities cannot be calculated from &S &S spreads . # ha+ard ha+ard rate is 1% per annum. annum. !hat !hat is the probability probability of a default during during the (rst two years" #. '.00% $. '.0'% . 1./% &. 1./6% 5. !hich !hich of of the foll follow owing ing is is true true #. )he default probability probability per year year for a company always always increases increases as we we loo- further ahead $. )he default probability probability per year year for a company always always decreases decreases as we loo- further ahead . Sometimes Sometimes # is true true and someti sometimes mes $ is true &. )he default default probability probability per year year is roughly constant for most companies
6. !hich of the following is true #. onditional default probabilities are at least as high as unconditional default probabilities $. onditional default probabilities are at least as low as unconditional default probabilities . onditional default probabilities are sometimes lower and sometimes higher than unconditional default probabilities. &. )here is no dierence between conditional and unconditional default probabilities because a company can only default once. 2. f a company*s (ve year credit spread is '00 basis points and the recovery rate in the event of a default is estimated to be '0% what is the average ha+ard rate per year over the (ve years #. 0.% $. 1.'% . 1.% &. '.5% . !hich of the following is true #. ecovery rates are lower for investment grade companies $. ecovery rates are higher for noninvestment grade companies . ecovery rates are negatively correlated with default rates &. ecovery rates are positively correlated with default rates /. !hich of the following is true #. )he asset swap spread is a measure of e4cess of the bond yield over the S rate $. )he asset swap spread is a measure of e4cess of the bond yield over the $7swap rate . #n asset swap e4changes the actual return on the asset for $ plus a spread &. 8one of the above 10.)o be investment grade, a company has to have a credit rating of #. ## or better $. # or better . $$$ or better &. $$ or better 11.n the 9aussian copula model which of the following is true #. )he time to default for a company is assumed to be normally distributed. $. )he time to default for a company is assumed to be lognormally distributed . )he time to default for a company is transformed to a normal distribution &. )he time to default for a company is transformed to a lognormal distribution
1'.!hich of the following is true #. 8etting always leads to a reduction in a company*s e4posure to a counterparty $. 8etting always leads to a company*s e4posure to a counterparty either staying the same or going down . 8etting always increases a company*s e4posure to a counterparty &. 8etting can increase or reduce the e4posure
13.!hich of the following is true #. &owngrade triggers are particularly valuable if they are widely used by a company*s counterparties $. &owngrade triggers become less valuable if they are widely used by a company*s counterparties . &owngrade triggers are useless because their impact is always anticipated by the mar-et &. &owngrade triggers are a twoedged sword. f company # has a downgrade trigger for company $ then company $ has a downgrade trigger for company # 1.!hich of the following is true of :erton*s model; #. )he e# per option purchased from the counterparty" #. =0.1/ $. =1.1/ . =0.'/
&. =1.'/ 1.!hich of the following is true #. # derivative dealer*s ># is the counterparty*s &># and vice versa $. ollateral posted by the counterparty reduces ># . ollateral posted by the dealer reduces &># &. #ll of the above
1/.)he credit spreads for a counterparty for 5 and 6 years are '% and '.'% respectively. )he recovery rate is 60%. !hat is closest to the unconditional default probability for the si4th year" #. 0.0 $. 0.05 . 0.06 &. 0.02 '0.!hich of the following is true of reditmetrics when it is used to calculate credit >a #. reditmetrics ta-es defaults but not downgrades into account $. reditmetrics ta-es downgrades but not defaults into account . reditmetrics considers neither defaults nor downgrades &. reditmetrics considers both defaults and downgrades
