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Q: Credit risk has always existed. Since the early 1990s, credit derivatives have become dominant in the capital markets. How do these instruments serve to reduce and/or transfer risk? Can you think of ways in which the existence of credit derivatives has made the financial markets more efficient?

Q: What is a credit default swap and what function does it serve?

Q: What is meant by the phrase "tranche" when referring to collateralized debt obligations?

Q: What is the recovery rate?

Q: What does a transition matrix indicate about a bond's future credit risk?

Q: What are the two ways that the payoff conditional on default can be expressed?

Q: A firm has a single issue of a zero coupon debt that promises to pay $40 in 5 years, and the A0 = $50, r = 4%, Ïƒ = 12%, and Î´ = 0. If the asset has a 5% chance of total default, what is the value of the debt?A) $30.83B) $42.68C) $55.21D) $62.41

Q: A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years, and the A0 = $100, r = 4%, Ïƒ = 25%, and Î´ = 0. If the asset has a 2% chance of total default, what is the yield on the bond? A) 8.32% B) 12.33% C) 24.36% D) 36.85%

Q: A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years, and the A0 = $100, r = 4%, Ïƒ = 25%, and Î´ = 0. If the asset has a 2% chance of total default, what is the value of the debt? A) $67.10 B) $75.19 C) $85.62 D) $90.00

Q: A firm has a single issue of a zero coupon debt that promises to pay $90 in 4 years, and the A0 = $100, r = 5%, Ïƒ = 15%, and Î´ = 0. If the asset has no chance of total default, what is the value of the debt? A) $67.10 B) $75.19 C) $85.62 D) $90.00

Q: Suppose that B = $500 and A0 = $470, Î± = 9%, r = 4%, Ïƒ = 17%, and Î´ = 0. If T = 8, what is the recovery rate assuming risk neutral default probability? A) $369 B) $400 C) $470 D) $500

Q: Suppose that B = $500 and A0 = $470, Î± = 9%, r = 4%, Ïƒ = 17%, and Î´ = 0. If T = 8, what is the recovery rate assuming true default probability? A) $369 B) $400 C) $470 D) $500

Q: Suppose that B = $500 and A0 = $470, Î± = 9%, r = 4%, Ïƒ = 17%, and Î´ = 0. If T = 8, what is the risk neutral default probability? A) 13.0% B) 20.5% C) 38.3% D) 44.4%

Q: Suppose that B = $500 and A0 = $470, Î± = 9%, r = 4%, Ïƒ = 17%, and Î´ = 0. If T = 8, what is the true default probability? A) 13.0% B) 20.5% C) 38.3% D) 44.4%

Q: A bond has a current value of $950 and promises to pay $1,000 at the end of 4 years. The expected return on the asset is 12% and the risk free rate is 3%. If the actual cash payout in case of default is 0, what is the risk neutral default probability given that the asset has a standard deviation of 18%? A) 15.2% B) 21.5% C) 33.2% D) 49.6%

Q: A bond has a current value of $950 and promises to pay $1,000 at the end of 4 years. The expected return on the asset is 12% and the risk free rate is 3%. If the actual cash payout in case of default is 0, what is the true default probability given that the asset has a standard deviation of 18%? A) 15.2% B) 21.5% C) 33.2% D) 49.6%

Q: The chance that a counter party may fail to meet a contractual obligation on a debt instrument is referred to as: A) Credit risk B) Credit spread C) Loss given default D) Recovery rate

Q: The difference between the yield to maturity on a defaultable bond and an otherwise equivalent default-free bind is called the: A) Credit risk B) Credit spread C) Loss given default D) Recovery rate

Q: You own $4 million of Jacko Corp. The expected return is 14.0% and Ïƒ = 0.20. What is the value at risk over 4 weeks at a 99% confidence level? A) $383,000 B) $413,000 C) $453,000 D) $473,000

Q: Your portfolio is worth $200,000. The standard deviation of its annual returns is 0.20 and the expected return is 11.0%. What is the 2-week value at risk at a 95% confidence level? A) $12,058 B) $13,058 C) $14,058 D) $15,058

Q: Your portfolio is worth $200,000. The standard deviation of its annual returns is 0.20 and the expected return is 11.0%. What is the probability of a loss over 10 business days? A) 39.84% B) 49.84% C) 59.84% D) 69.84%

Q: Why is VaR an important tool in measuring risk? What are some of its shortcomings?

Q: What is a default swap and what is its use?

Q: How is VaR used in credit risk scenarios?

Q: What is bootstrapping and what is its use?

Q: Why is recent data more relevant than older data when calculating volatility?

Q: What is implied volatility?

Q: Use VaR techniques to determine the cost of insurance on a risky investment. The investment asset has a value of $80 and pays no dividend. The historical standard deviation of the asset is 15% and the expected return on the asset is 8%. At the 95% confidence level, what is the price of a put option that insures the asset over the next year?A) $2.56B) $1.25C) $0.86D) $0.15

Q: Use VaR techniques to determine the cost of insurance on a risky investment. The investment asset has a value of $150 and pays no dividend. The historical standard deviation of the asset is 20% and the expected return on the asset is 15%. At the 95% confidence level, what is the price of a put option that insures the asset over the next 6 months? A) $0.33 B) $1.25 C) $2.65 D) $6.56

Q: A stock has a price of $42.63 and pays no dividend. The historical standard deviation of the stock is 18% and the expected return on the stock is 11%. At the 95% confidence level, what is the Tail VaR over the next 270 days? A) $2.13 B) $6.56 C) $9.71 D) $40.50

Q: A stock has a price of $50 and pays no dividend. The historical standard deviation of the stock is 25% and the expected return on the stock is 12%. At the 95% confidence level, what is the Tail VaR over the next 6 months? A) $2.50 B) $13.63 C) $22.36 D) $47.50

Q: You own two bonds; 25% of a 30-year bond with Ïƒ = 0.02 and 75% of a 20-year bond with Ïƒ = 0.015. The correlation coefficient is 0.82. What is the 2-week value at risk at a 95% confidence level? (Assume portfolio value = $15 million.) A) $0 B) $234,357 C) $734,357 D) $1,734,357

Q: A bond maturing in 5 years has a YTM = 0.065 and an annual yield volatility of 2.0%. Given a $15 million portfolio, what is the value at risk over 2 weeks at a 95% confidence level? A) $283,917 B) $383,917 C) $483,917 D) $583,917

Q: Matt owns 5,000 share of Matrix at $52.50. To arbitrage this he shorts 5,000 calls and longs 5,000 puts at a strike of $50.00. Assume = 0.16, Ïƒ = 0.30, rf = 0.06, and the options expire in 170 days. What is the value at risk for 1 week at a 95% confidence level? A) $0 B) $16,433 C) $18,433 D) $20,433

Q: Kelly owns 50,000 shares of Microsoft at $63.60 per share. She buys 20,000 $60 strike calls. Assume = 0.12, Ïƒ = 0.23, rf = 0.05, and the options expire in 170 days. What is the value at risk for 2 weeks, using the delta approximation at a 99% confidence level? A) $311,463 B) $411,463 C) $511,463 D) $611,463

Q: Harold owns 10,000 shares of IBM at $54.50 per share. He writes $55 strike covered call on all the shares. Assume = 0.14, Ïƒ = 0.18, rf = 0.04, and the options expire in 90 days. What is the value at risk for 1 day, using the delta approximation at a 95% confidence level? A) $4,717 B) $5,717 C) $6,717 D) $7,717

Q: Your $2 million portfolio consists of 25% Evans stock with = 0.16, Ïƒ = 0.22 and 75% Indy stock with = 0.09, Ïƒ = 0.12. The correlation coefficient is 0.65. What is the value at risk over 1 day at a 99% confidence level? Assume 252 days per year. A) $27,976 B) $37,976 C) $47,976 D) $57,976

Q: Your $2 million portfolio consists of 25% Evans stock with = 0.16, Ïƒ = 0.22 and 75% Indy stock with = 0.09, Ïƒ = 0.12. The correlation coefficient is 0.13. What is the value at risk over 1 day at a 99% confidence level? Assume 252 days per year. A) $21,792 B) $31,792 C) $41,792 D) $51,792

Q: Your $1 million portfolio consists of 50% of Jacko with = 0.14, Ïƒ = 0.20 and 50% of Macko with = 0.10, Ïƒ = 0.15. The correlation coefficient is 0.25. What is the value at risk over 1 week at a 95% confidence level? A) $23,447 B) $26,447 C) $29,447 D) $32,447

Q: What are the various models in bond pricing and behavior?

Q: What is calibration?

Q: Under what conditions does delta-gamma-theta approximate the exact bond price change?

Q: Describe the effectiveness of duration as a tool in hedging bonds.

Q: How does the node configuration in interest rates and bonds differ from stocks?

Q: What is the transaction that results within an interest rate cap to make the holder's rate "capped"?

Q: Using base 100 pricing, the price of bonds that mature in years 1, 2, 3, and 4 is 93.46, 92.22, 91 98 and 90.23, respectively. Given this data, what is the 2-year forward price for a 2-year bond?A) 97.84B) 98.92C) 99.74D) 160.45

Q: Using base 100 pricing, the price of bonds that mature in years 1, 2, and 3 is 101.92, 100.87, and 99.34, respectively. Given this data, what is the 2-year forward price for a 1-year bond? A) 98.48 B) 99.34 C) 100.22 D) 100.87

Q: The price of a bond that matures in 1 year is 103.34, using base 100 pricing. The price of a bond that matures in two years is 101.90, using base 100 pricing. What is the 1-year bond forward price in year 1? A) 98.56 B) 98.61 C) 101.90 D) 103.34

Q: If next year's bond prices for 3-year zero coupon bonds may be either 0.8923 or 0.8644, what is the yield volatility? A) 12.7% B) 13.7% C) 14.7% D) 15.7%

Q: If next year's bond prices for 2-year zero coupon bonds may be either 0.9454 or 0.9233, what is the yield volatility? A) 18% B) 16% C) 14% D) 12%

Q: Assume a = 0.25, b = 0.13, r = 0.06, and Ïƒ = 0.25. Using the CIR model, calculate the gamma of a zero coupon bond maturing in 3 years. A) 2.14 B) 2.34 C) 2.54 D) 2.74

Q: Assume a = 0.15, b = 0.08, r = 0.05, and 0.30. Using the CIR model, calculate the delta of a zero coupon bond maturing in 5 years. A) -4.08 B) -3.08 C) -2.08 D) -1.08

Q: Assume a = 0.10, b = 0.15, r = 0.04 and Ïƒ = 0.35. Using the CIR model, calculate the price of a zero coupon bond maturing in 6 years. A) 0.6042 B) 0.7042 C) 0.8042 D) 0.9042

Q: A series of 1-year interest rate caplets for 4 years have values of $0.05, $0.07, $0.08, and $0.10, respectively. What is the value of a 3-year interest rate cap? A) $0.08 B) $0.12 C) $0.20 D) $0.30

Q: Bonds maturing in 1, 2, and 3 years have prices of 0.9323, 0.8762, and 0.8002, respectively. A 0.8900 call on a 1-year bond matures in 1 year with Ïƒ = 0.25. What is the price of a 10.0% interest rate caplet that expires in 1 year? A) $0.50 B) $0.60 C) $0.70 D) $0.80

Q: Bonds maturing in 1, 2, and 3 years have prices of 0.9600, 0.9153 and 0.8620, respectively. A 0.9300 strike call on a 1-year bond matures in 1 year with Ïƒ = 0.20. What is the price of an 8.0% interest rate caplet that expires in 1 year? A) $0.66 B) $0.76 C) $0.86 D) $0.96

Q: Bonds maturing in 1, 2, and 3 years have prices of 0.9020, 0.8320, and 0.7620, respectively. What is the price of a put option that expires in 1 year that gives you the right to sell a 1-year bond for a price of 0.9200? Assume Ïƒ = 0.18. A) $0.35 B) $0.25 C) $0.15 D) $0.05

Q: Zero-coupon bonds maturing in 1, 2, and 3 years have prices of 0.9020, 0.8320, and 0.7620, respectively. What is the implied forward rate from year 2 to year 3? A) 7.94% B) 9.19% C) 09.68% D) 10.21%

Q: Bonds maturing in 1, 2, and 3 years have prices of 0.9345, 0.8766, and 0.8212, respectively. What is the price of a call option that expires in two years and gives you the right to pay 0.8600 to buy the 1-year bond? Assume Ïƒ = 0.15. A) $0.015 B) $0.105 C) $0.205 D) $0.305

Q: Zero-coupon bonds maturing in 1, 2, and 3 years have prices of 0.9345, 0.8766, and 0.8212, respectively. What is the forward price for a 1-year bond purchased in year 2? A) 0.6866 B) 0.7234 C) 0.8787 D) 0.9368

Q: Ask students to provide a definition of forecasted volatility and market efficiency. Begin a discussion of the consistency or inconsistency that may exist between these two concepts. Is it possible that markets are inefficient if volatility can be forecasted? If so, how can someone take advantage of this inefficiency to make excess returns?

Q: What is the primary difference between ARCH models and GARCH models?

Q: What concept helped Robert Engle win the Nobel Prize for economics in 2003 and what was its basic tenant?

Q: Why would an exponentially weighted moving average be a more accurate means of calculating volatility than a simple sampling of historical data?

Q: What is the one aspect of volatility that is assumed in the Black-Scholes model and why might that assumption be in error?

Q: Explain the pattern of implied volatility that is often referred to as a smirk. (Use a call as your example.)

Q: The negative correlation between stock prices and volatility is referred to as the:A) Correlation effectB) Correlation riskC) Leverage effectD) Leverage risk

Q: A forward contract that pays ln(ST/S0) and can be used to hedge or speculate on variance is called a ________ contract. A) Growth B) Log C) Variance D) Volatility

Q: A forward contract that pays the difference between a forward price and some measure of the realized stock variance is called a Variance: A) Skew B) Smile C) Surface D) Swap

Q: The sum of the squared, continuously compounded returns used to calculate a volatility is referred to as: A) ARCH B) EWMA C) GARCH D) Realized quadratic variation

Q: The process of emphasizing more recent observations of data in calculating volatility is commonly known as: A) ARCH B) EWMA C) GARCH D) Realized quadratic variation

Q: When the volatility of an asset is higher at the deep in the money and deep out of the money positions, than at the money, the plot is called a volatility: A) Skew B) Smile C) Smirk D) Surface

Q: Plotting the volatility of a security in a three dimensional graph, using time to maturity on one axis and strike price on another, is referred to as volatility: A) Skew B) Smile C) Smirk D) Surface

Q: The S&P 100 Index implied volatility since 2003 is published by the CBOE under the ticker symbol: A) IVX B) SP1X C) VIX D) VXO

Q: The S&P 100 Index implied volatility prior to 2003 is published by the CBOE under the ticker symbol: A) IVX B) SP1X C) VIX D) VXO

Q: During periods when measured volatility is high, the typical day tends to exhibit high volatility. This behavior is referred to as volatility: A) Clustering B) EWMA C) Smile D) Stochasticity

Q: A stock price has a historical volatility of 24%. If an anomalous event occurs to the company in the next past two days, which was not anticipated, what is the most likely implied estimate of the unconditional volatility using the GARCH model? A) 12% B) 20% C) 27% D) 45%

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