add more PE credit

Gradio_UI.py

@@ -268,13 +268,13 @@ class GradioUI:
                 # Optional icon
             },
             {
-                "text": "Explain the concept of gradient descent.",  # Message to populate
-                "display_text": "Example 2: Gradient Descent",  # Text to display in the example box
+                "text": "Create a study plan for FRM Part 1.",  # Message to populate
+                "display_text": "Example 2: Create a study plan for FRM Part 1.",  # Text to display in the example box
                 # Optional icon
             },
             {
-                "text": "What is the capital of France?",  # Message to populate
-                "display_text": "Example 3: Capital of France",  # Text to display in the example box
+                "text": "Give me a practice question on bond valuation.",  # Message to populate
+                "display_text": "Example 3: Give me a practice question on bond valuation.",  # Text to display in the example box
             },
         ]
         with gr.Blocks(fill_height=True) as demo:

PE/new 1.txt

@@ -0,0 +1,328 @@
+1.Golin and Delhaise divide credit analysis into four areas according to borrower type:
+I. Consumer credit analysis is the evaluation of the creditworthiness of individualconsumers;
+II.Corporate credit analysis is the evaluation of nonfinancial companies such asmanufacturers, and nonfinancial service providers;
+III.Financial institution credit analysis is the evaluation of financial companiesincluding banks and nonbank financial institutions, such as insurance companiesand investment funds;
+IV.Sovereign/municipal credit analysis is the evaluation of the credit risk associatedwith the financial obligations of nations, subnational governments, and publicauthorities, as well as the impact of such risks on obligations of nonstate entitiesoperating in specific jurisdictions.
+According to Golin and Delhaise, each of the following is true about key features of credit analysis with respect to borrower type, except which is not true?
+A. Individuals (consumers): Credit analysis is amenable to automation and the use of scoring models and statistical tools to correlate risk to limited number of variables
+B. Non-financial corporations: Compared to consumers, tends to be more detailed and "hands-on" (i.e. less automated); key variables are likely to include liquidity, cash flow, near-term earnings capacity and profitability, solvency or capital position
+C. Financial Companies: In contrast to corporate (non-financial) credit analysis, qualitative analysis and asset quality are not important, but cash flow is a highly important (a "key indicator")
+D. Sovereigns: Includes analysis of country risk, which is primarily political dynamics and state of the economy; and systematic risk, which includes the regulatory regime and the financial system
+1.Answer: C
+Credit analysis of financial companies has much in common with corporate credit analysis, but the authors cite two key differences: With respect to financial companies, " The differences are: The importance of asset quality; The omission of cash flow as a key indicator."
+2.An analyst has noted that the default frequency in the pharmaceutical industry hasbeen constant at 8% for an extended period of time. Based on this information, whichof the following statements is most likely correct for a randomly selected firmfollowing a Bernoulli distribution?
+I. The cumulative probability that a randomly selected firm in the pharmaceuticalindustry will default is constant.
+II.The probability that the firm survives for the next 6 years without default isapproximately 60%.
+A. I only.
+B. II only.
+C. Both I and II.
+D. Neither I nor I.
+2.Answer: B
+Statement I is false because the cumulative probability of default increases (i.e., even the highest rated companies will eventually fail over a long enough period). Statement II is true since the probability the firm survives over the next 6 years without default is: (1 – 0.08)6= 60.6%.
+3.The forward probability of default for years one and two is 0.5% and 1.1%,respectively. If the cumulative probability of default for the 3-year period is 4.45%, theforward probability of default for year three is closest to:
+A. 2.8%
+B. 3.2%
+C. 2.9%
+D. 2.7%
+3.Answer: C
+The cumulative probability of default is equal to one minus the probability of surviving to the end of the period without default: C2=1−(1−𝑑𝑑1)(1−𝑑𝑑2)(1−𝑑𝑑3) 0.0445=1−(1−0.005)(1−0.011)(1−𝑑𝑑3) ⇒𝑑𝑑3=2.9%
+4.An analyst has gathered the following information about ABC Inc. and DEF Inc. Therespective credit ratings are AA and BBB with 1-year CDS spreads of 200 and 300basis points each. The associated probabilities of default based on published reportsare 10% and 20%, respectively. Which of the following statements about the recoveryrates is most likely correct?
+A. The market implied recovery rates are equal.
+B. The market implied recovery rates is higher for ABC.
+C. The market implied recovery rates is lower for ABC.
+D. The loss given default is higher for DEF.
+4.Answer: C
+The approximation of credit spread = (1 – RR)×(PD). This implies:
+ABC: 200bps=(1−RR)×10%, so RR = 80%.
+DEF: 300bps=(1−RR)×20%, so RR = 85%.
+Thus, the market implied recovery rate is lower for ABC. Using loss given default terminology, LGD for ABC = 20% and LGD for DEF = 15%.
+5.A firm has issued a single zero-coupon bond that matures in 5 years and has a facevalue of 100. Assume that the volatility of the firm value is 0.5, that the risk-free rate is0.04, and that firm value equal to 400. Using the Merton model, what is the value ofthe bond?
+In the following table, N(d) denotes the cumulative distribution function for a standardnormal distribution evaluate at d.
+D
+N(d)
+d
+N(d)
+-1.978
+0.024
+0.681
+0.752
+-1.960
+0.025
+0.860
+0.805
+-1.799
+0.036
+0.995
+0.840
+-1.505
+0.066
+1.505
+0.934
+-0.995
+0.160
+1.799
+0.964
+-0.681
+0.248
+1.960
+0.975
+-0.123
+0.451
+1.978
+0.976
+A. 75.50
+B. 324.47
+C. 310.40
+D. 89.60
+5.Answer: A
+V=400，F=100，r=0.04，σ=0.5，T−t=5 Bond=V×N(−d1)+Fe−r×(T−t)×N(d2) d1,2=ln[V/F×e−r×（T−t）]σ×√T−t±12×σ×√T−t d1=1.978,d2=0.860 Bond=75.50
+6.The capital structure of ABC Corporation consists of two parts, one 5 year bond withface value of $100 million and the rest is equity. The current market value of the firmassets is $130 and the expected rate of change of the firm’s value is 25%. Thevolatility is 30%. The firm’s risk management division estimates the distance todefault using Merton model. Given the distance to default, the estimated physicaldefault probability is? (N(1.92) = 97.25%; N(2.58) = 99.52%)
+A. 2.75%
+B. 12.78%
+C. 12.79%
+D. 30.56%
+6.Answer: A
+d2=ln [130/(100e−25%×5)]0.3×√5−0.3×√52=1.92
+The physical default probability is N(−d2) = 2.75%
+7.Suppose a firm has two debt issues outstanding. One is a senior debt issue thatmatures in three years with a principal amount of $100 million. The other is asubordinate debt issue that also matures in three years with a principal amount of $50million. The annual interest rate is 5% and the volatility of the firm value is estimatedto be 15%. If the volatility of the firm value declines in the Merton model then which ofthe following statements is true?
+A. If the firm is experiencing financial distress (low firm value), then the value ofsenior debt will increase while the values of subordinate debt and equity will both decline.
+B. If the firm is not experiencing financial distress (high firm value), then the value of senior debt and subordinate debt and equity will increase.
+C. If the firm is experiencing financial distress (low firm value), then the value of senior debt and subordinate debt will increase while equity values will declines.
+D. If the firm is not experiencing financial distress (high firm value), then the value of senior debt will increase while the values of subordinate debt and equity will both decline.
+7.Answer: A
+When firms with subordinate debt are experiencing financial distress (low firm values), changes in the value of subordinate will react to changes in the model parameters in the same way as equity. Since equity is valued as a call option in the Merton model, a decline in volatility will reduce the value of equity (and subordinate debt). When firms with subordinate debt are not experiencing financial distress (high firm values), changes in the value of subordinate will react to changes in the model parameters in the same way as senior debt. Since senior debt is valued as the difference in firm value less equity valued as a call option in the Merton model, a decline in volatility will increase the value of senior debt (and subordinate debt).
+8. Which of the following statements regarding the Merton model is true?
+A. A firm with numerous debt issues that mature at different times is easy to value with the Merton model.
+B. The Merton model assumes a lognormal distribution and constant variance for changes in firm value.
+C. The Merton model is able to predict default because it allows for default surprises (i.e., jumps).
+D. Empirical results indicate that the Merton model is able to predict default better than naïve models for investment grade bonds.
+8. Answer: B
+Most firms have a variety of debt instruments that mature at different times and have many different coupon rates (i.e., not just zero-coupons as assumed by the Merton model); therefore, Choice A is false. The Merton model assumes that the underlying asset follows a lognormal distribution with constant variance; therefore, Choice B is true. The Merton model does not allow the firm value to jump. Since most defaults are surprises, the inability to have jumps in the firm value in the Merton model makes default too predictable; Therefore, Choice C is false. Jone, Mason, Rosenfeld (1984) report that a naïve model of predicting that debt is riskless works better for investment grade bonds than the Merton model. However, the Merton model works better than the naïve model for debt below investment grade; therefore, Choice D is false.
+9. The Merton model and the Moody’s KMV model use different approaches to determine the probability of default. Which of the following is consistent with Moody’s KMV model?
+A. The distance to default is 1.96, so there is a 2.5% probability of default.
+B. The distance to default is 1.96, so there is a 5.0% probability of default.
+C. The historical frequency of default for corporate bonds has been 6%. Updating this with Altman’s Z-score analysis would provide a probability of default that is somewhat different than 6%.
+D. The distance to default is 1.96 and, historically, 1.2% of firms with this characterization have defaulted, so there is a 1.2% probability of default.
+9. Answer: D
+Moody’s KMV model evaluates the historical frequency of default for firms with similar distances to default and uses this as the probability of default.
+10. Under single-factor model, a firm has a beta of 0.40 and an unconditional default probability of 1%. If we enter a modest economic downturn, such that the value of m = −1.0, what is the conditional default probability? N(2.1) = 0.9820
+A. 1.0%
+B. 1.8%
+C. 2.5%
+D. 2.8%
+10. Answer: B
+Conditional default has a mean of 0.40×(−1) = −0.40 and a volatility of√1−0.42=0.92.The loss threshold is −2.33. Therefore the conditional default probability is: Φ􁉀−2.33+0.40.92􁉁=1.8%
+11. Given a hazard rate of 0.15, find the probability when a company defaults in year two after surviving the first year.
+A. 0.1393
+B. 0.2592
+C. 0.7408
+D. 0.8607
+11. Answer: A
+T
+Cumulative PD
+Survival Probability
+PD (t, t+1)
+Conditional PD Given Survival Until Time t
+1
+1 – 𝑒𝑒−0.15 = 0.1393
+1 – 0.1393 = 0.8607
+0.1393
+2
+1 – 𝑒𝑒−0.15×2 =0.2592
+1 – 0.2592 = 0.7408
+0.2592 – 0.1393 = 0.1199
+0.1199/0.8607 = 0.1393
+12. Which of the following statements regarding counterparty credit risk are correct?
+I. Expected positive exposure is the highest expected exposure over a specified interval.
+II. Wrong-way exposures are positively correlated with the counterparty’s credit quality.
+III. Credit triggers are early settlement agreements that require counterparties to settle and terminate trades if the credit rating of a party falls below a specified level.
+IV. Right-way exposures are negatively correlated with the counterparty’s credit quality.
+V. Cross-product netting is a provision that allows counterparties to net payments across different products.
+VI. Collateral agreements require that specified amounts of liabilities be transferred to counterparty if exposures exceed a specified threshold.
+A. III and V only.
+B. I, III, and V.
+C. I, II, and IV.
+D. III, V, and VI.
+12. Answer: A
+Credit triggers are early settlement agreements that require counterparties to settle and terminate trades if the credit rating of a party falls below a specified level. Cross-product netting is a provision that allows counterparties to net payments across different products. Expected positive exposure is the average expected exposure over a specified interval. Wrong-way exposures are negatively correlated with the counterparty’s credit quality Right-way exposures are positively correlated with the counterparty’s credit quality. Collateral agreements require that specified amounts of assets be transferred to a counterparty if exposures exceed a specified threshold.
+13. Which of the following security types correspond to the PFE graphs below?
+A. Loan
+B. Interest Rate Swap
+C. Currency Swap
+D. Bond
+13. Answer: C
+For currency swap, the majority of the exposure results from the uncertainty regarding the final notional value payment associated with FX rate risk.
+Month
+0
+12
+24
+36
+48
+60
+72
+84
+96
+108
+120
+0
+4
+8
+12
+16
+20
+Maximum
+Expected
+14. A risk manager needs a quick calculation of the BCVA on a swap. Assume inputs are as follows: EPE = 5%, ENE = 3%, counterparty credit spread = 300bps, financial institution credit spread = 200 bps. Compute BCVA from the perspective of the financial institution.
+A. -1
+B. 1
+C. 9
+D. -9
+14. Answer: C
+From the perspective of the financial institution: EPE×counterparty credit spread−ENE×institution credit sprea =5%×300−3%×200=9bps
+This is what the financial institution may charge the counterparty for overall counterparty risk.
+15. Which of the following statements regarding wrong-way risk and right-way risk is correct?
+A. A long put option is subject to wrong-way risk if both risk exposure and counterparty default probability decrease.
+B. A long call option experiences right-way risk if the interaction between risk exposure and counterparty default probability produces an overall decline in counterparty risk.
+C. Declining local currency can decrease the position gain in a foreign currency transaction, while increasing risk exposure of the counterparty.
+D. The 2007-2008 credit crisis provides an example of wrong-way risk from the perspective of a long who had sold credit default swaps (CDSs) as protection against bond issuers’ default.
+15. Answer: B
+A long call option experiences right-way risk if risk exposure and counterparty default probability results in decreased counterparty risk. A long put option is subject to wrong-way risk if both risk exposure and counterparty default probability increase. Declining local currency can increase the position gain in a foreign currency transaction, while increasing counterparty risk exposure. The 2007-2008 credit crisis provides an example of wrong-way risk from the perspective of a long who had bought CDSs as protection against bond issuers’ default.
+16. Consider two portfolios. One with USD 100 million credit exposure to a single B-rated counterparty. The second with USD 100 million on credit exposure split evenly between 50 B-rated counterparties. Assume that default probabilities and recovery rates are the same for all B-rated counterparties. Which of the following is correct?
+A. The expected loss of the first portfolio is greater than the expected loss of the second portfolio AND the unexpected loss of the first portfolio is greater than the unexpected loss of the second portfolio.
+B. The expected loss of the first portfolio is greater than the expected loss of the second portfolio AND the unexpected loss of the first portfolio is equal to the unexpected loss of the second portfolio.
+C. The expected loss of the first portfolio is equal to the expected loss of the second portfolio AND the unexpected loss of the first portfolio is equal to the unexpected loss of the second portfolio.
+D. The expected loss of the first portfolio is equal to the expected loss of the second portfolio AND the unexpected loss of the first portfolio is greater than the unexpected loss of the second portfolio.
+16. Answer: D
+There’s diversification effect in unexpected loss.
+17. Suppose there is a $1,000,000 portfolio with n credits that each have a default probability, π = 2% and a zero recovery rate. The default correlation is 0 and n = 1,000. There is a probability of 28 defaults at the 95th percentile based on the binomial distribution with the parameters of n = 1,000 and π = 0.02. What is the credit VaR at the 95% confidence level based on these parameters?
+A. $7,000
+B. $8,000
+C. $9,000
+D. $10,000
+17. Answer: B
+The 95th percentile of the credit loss distribution is $28,000 (28×$1,000,000/1,000). The expected loss is $20,000 ($1,000,000×0.02). The credit VaR is then $8,000 ($28,000 − $20,000).
+18. Suppose a portfolio has a notional value of $1,000,000 with 20 credit positions. Each of the credits has a default probability of 2% and a recovery rate of zero. Each credit position in the portfolio is an obligation from the same obligor, and therefore, the credit portfolio has a default correlation equal to 1. What is the credit value at risk at the 99% confidence level for this credit portfolio?
+A. $0
+B. $1,000
+C. $20,000
+D. $980,000
+18. Answer: D
+With the default correlation equal to 1, the portfolio will act as if there is only one credit. Viewing the portfolio as a binomial distributed random variable, there are only two possible outcomes for a portfolio acting as one credit. The portfolio has a 2% probability of total loss and a 98% probability of zero loss. Therefore, with a recovery rate of zero, the extreme loss given default is $1,000,000. The expected loss is equal to the portfolio value times π and is $20,000 in this example. The credit VaR is defined as the quantile of the credit loss less the expected loss of the portfolio. At the 99% confidence level, the credit VaR is equal to $980,000.
+19. Bank A, which is AAA rated, trades a 10-year interest rate swap (semi-annual payments) with Bank B, which is rated A-. Because of Bank B's poor credit rating, Bank A is concerned about the 10-year exposure it is going to run because of the swap deal. Which of the following measures help mitigate Bank A's credit exposure to Bank B?
+I. Negotiate a CSA with Bank B and efficiently manage the collateral management system
+II. Execute the swap deal as a reset swap wherein the swap will be marked to market every six months
+III. Execute the swap deal with a break clause in the fifth year
+IV. Decrease the frequency of coupon payments from semi-annual to annual
+A. I only
+B. IV only
+C. I, II, III and IV
+D. I, II and III
+19. Answer: D
+'I' is correct. Negotiating a CSA and getting collateral from the counterparty is an effective way of mitigating credit exposure.
+'II' is correct. In a reset swap since the swap is marked to market every period, the credit exposure we run is only for that period i.e. till the next reset; this implies lesser exposure.
+'III' is correct. A break clause is always useful since it gives the counterparties an opportunity to assess whether they want to continue for the rest of the term of the swap.
+'IV' is incorrect. Decreasing the frequency of payments increases the credit exposure rather than decreasing it. This is because, more the time for the next payment, greater are the chances for the market rates to move in one counterparty's favor, thereby increasing its credit exposure to the other counterparty.
+20. Which of the following would not generally decrease credit risk?
+A. Entering into an interest-rate swap with a counterparty
+B. Signing a legally-binding netting agreement covering a portfolio of OTC derivative trades with a counterparty
+C. Clearing an existing trade through a clearing house
+D. Purchasing a credit derivative from a AAA-rated institution that pays USD 5 million if a bond defaults
+20. Answer: A
+A is correct. Entering into an interest rate swap causes the firm to be exposed to the credit risk of the swap counterparty.
+B is incorrect. Netting agreements are one of the most powerful ways for controlling exposures. The purpose of these agreements is to provide for netting of payments across a set of contracts.
+C is incorrect. Executing a trade through a clearing house will generally decrease credit risk. The counterparty to the contract is now the clearinghouse. Most clearinghouses are well capitalized and their risk of default is effectively zero.
+D is incorrect. Credit derivatives are contracts that pass credit risk from one counterparty to another. A long position in the credit derivative will help to decrease credit risk as it pays USD 5 million if the bond defaults.
+21. A 2-year credit default swap (CDS) specifying physical delivery defaults at the end of two years. If the reference asset is a $200 million, 8.0% ABC corporate bond, and the CDS spread is 125 basis points, the buyer of the CDS will:
+A. Receive payments of 800 basis points for the next two years.
+B. Receive a payment of $167.5 million.
+C. Deliver the bond and receive a payment of $200 million.
+D. Continue to receive payments of 675 basis points for the next two years.
+21. Answer: C
+If the swap specifies physical delivery, the buyer of the swap will deliver the reference obligation to the seller and receive the par value of the obligation.
+22. You are currently long $10,000,000 par value, 8% XYZ bonds. To hedge your position, you must decide between credit protection via a 5-year CDS with 60bp annual premiums or digital swap with 50% payout with 50bp annual premiums. After one year, XYZ has defaulted on its debt obligations and currently trades at 60% of par. Which of the following statements is true?
+A. The contingent payment from the protection buyer to the protection seller is greater under the single-name CDS than the digital swap.
+B. The contingent payment from the protection buyer to the protection seller is less under the single-name CDS than the digital swap.
+C. The contingent payment from the protection seller to the protection buyer is greater under the single-name CDS than the digital swap.
+D. The contingent payment from the protection seller to the protection buyer is less under the single-name CDS than the digital swap.
+22. Answer: D
+Choices A and B can be eliminated because payments in default are made from protection seller to protection buyer. The payoff from the digital swap will be 50% of par value while the payoff from the single name will be 40% (i.e., 1 – 0.6) of par value.
+23. A six-year CDS on an AA-rated issuer is offered at 150bp with semiannual payments while the yield on a six-year semiannual coupon bond of this issuer is 8%. There is no counterparty risk on the CDS. The annualized LIBOR rate paid every six months is 4.6% for all maturities. Which strategy would exploit the arbitrage opportunity? How much would your return exceed LIBOR?
+A. Buy the bond and the CDS with a risk-free gain of 1.9%.
+B. Buy the bond and the CDS with a risk-free gain of 0.32%.
+C. Short the bond and sell CDS protection with a risk-free gain of 4.97%.
+D. There is no arbitrage opportunity as any apparent risk-free profit is necessarily compensation for being exposed to the credit risk of the issuer.
+23. Answer: A
+Because LIBOR is flat, the fixed-coupon yield is also 4.6%, creating a spread of 800 – 460 = 340bp on the bond. Going long the bond and short credit via buying the CDS yields an annual profit of 340 – 150 = 190bp.
+24. In pricing a first-to-default credit basket swap, which of the following is true, all else being equal?
+A. The lower the correlation between the assets of the basket, the lower the premium.
+B. The lower the correlation between the assets of the basket, the higher the premium.
+C. The higher the correlation between the assets of the basket, the higher the premium.
+D. The correlation between the assets has no impact in the premium of a first-to- default credit basket swap.
+24. Answer B
+The lower the correlation between the assets of the basket, the higher the premium. In the case of a first-to-default swap, a credit event occurs the first time any of the entities defaults. This swap provides default protection against losses related to this first default, but not to any subsequent defaults. Thus, the question is whether the level of correlation between assets of the basket increases or decreases the likelihood of the triggering event. If the correlation between the assets in a credit basket swap is lower, the basket would be exposed to greater default risk. For example, the basket contains assets from different sectors, then the basket would be exposed to the default risk of each and every sector in the basket. If the basket only contains assets from one sector, then the correlation is higher, and the default risk is lower.
+25. Bank One has made a $200 million loan to a software company at a fixed rate of 12 percent. The bank wants to hedge its exposure by entering into a Total Return Swap with a counterparty, Interloan Co., in which Bank One promises to pay the interest on the loan plus the change in the market value of the loan in exchange for LIBOR plus 40 basis points. If after one year, the market value of the loan has decreased by 3 percent and LIBOR is 11 percent, what will be the net obligation of Bank One?
+A. Net receipt of $4.8 million
+B. Net payment of $4.8 million
+C. Net receipt of $5.2 million
+D. Net payment of $5.2 million
+25. Answer: A
+Bank One would be due: ($200 million)×(0.11 + 0.0040)= $22.8 million and would owe: ($200 million)×(0.12) + ($200 million)×(−0.03)= $18.0 million
+The net obligation of Bank One would be $22.8 million – S18 million = $4.8 million.
+26. If a pool of mortgage loans begins the month with a balance of $10,500,000, has a scheduled principal payment of $54,800, and ends the month with a balance of $9,800,000, what is the CPR for this month?
+A. 6.177%
+B. 42.240%
+C. 53.472%
+D. 66.670%
+26. Answer: C
+We use the following formulas:SMM=prepaymentbeg.bal−scheduled principal payment and
+(1−SMM)12=(1−CPR)
+Prepayment = actual payment − scheduled payment = ($10,500,000 − $9,800,000) − $54,800 = $700,000 − $54,800 = $645,200.
+So: $645,200/($10,500,000−$54,800)=0.06177 and CPR=1−(1−0.06177)12=0.5347=53.47%
+27. A pass-through mortgage-backed security (MBS) with a weighted average maturity (WAM) of 30 months has an original principle balance of $2.0 billion. If the valuation model assumes a 300% PSA prepayment speed, which is nearest to the first month's prepaid (not scheduled) principal?
+A. $519,000
+B. $833,000
+C. $1.00 million
+D. $2.15 million
+27. Answer: C
+300%PSA=3×CPR=3×0.2%=0.6% SMM=1−(1−0.6%)112=0.05014% 0.05014%×2,000,000,000=1,002,760
+28. King Motors Acceptance Corporation (KMAC), the finance arm of King Motors, issues an auto-loan asset-backed security that consists of a senior tranche, denoted Tranche A in the amount of $50 million and an interest payment of 5 percent, and two subordinated tranches, denoted Tranches X and Z respectively, each with a face amount of $35 million. Tranche X pays investors annual interest at a rate of 6.5 percent while Tranche Z pays investors annual interest at a rate of 7.5 percent. Which of the following methods of credit support would NOT affect the credit quality of subordinated Tranche X?
+A. The total amount of the auto loans that make up the asset-backed issue is $125 million.
+B. The weighted average interest rate on the auto loans making up the pool is 6.4 percent.
+C. Any defaults on the part of King Motor’s customers will be first absorbed by Tranche Z.
+D. KMAC has a reserve in the amount of $10 million that will remain on KMAC’s balance sheet.
+28. Answer: D
+An investor’s claim when purchasing an ABS is solely with the ABS and no longer with the originator. The fact that KMAC has $10 million set aside means nothing for the ABS issue if it remains on KMAC’s balance sheet and is not part of the ABS issue. The other answer choices all describe forms of credit support that will support at least Tranches X and A, if not all 3 tranches. By having Tranche Z be subordinate to Tranche X, Tranche X has additional support. Also, loans of $125 million are used to back asset-backed securities worth ($50 + $35 + $35) = $120 million, which means the issue is over collateralized. The weighted average interest rate paid on the securities is approximately 6.2%. If the weighted average interest rate on the loans that make up the pool is 6.4% that means there is an excess spread between the loans and securities that also provides support for the entire issue.
+29. Assume there are 100 identical loans with a principal balance of $500,000 each. Based on a credit analysis, a 300 basis point spread is applied to the borrowers. LIBOR is currently 4% and the coupon rate will reset annually. The senior, junior, and equity tranches are 75%, 20%, and 5% of the pool, respectively. The spreads on the senior and mezzanine tranches are 2% and 6%. Excess cash flow is diverted to trust account above $1,000,000. Assume the default rate is 2%. What are the cash flows to the mezzanine and trust account in the first period?
+Mezzanine Trust account
+A. $1,000,000 $0
+B. $1,000,000 $180,000
+C. $2,250,000 $200,000
+D. $2,250,000 $250,000
+29. Answer: A
+The interest rate on the loans = 4%(LIBOR)+3%(spread) = 7%. Therefore,
+the total collateral cash flows in the first period = 100×$500,000×7%×(1 – 0.02) = $3,430,000. The senior tranche receives$50million×0.75×(4%+2%)=$2,250,000. Similarly, the mezzanine tranche receives$50million×0.20×(4%+6%)=$1,000,000. Next, the residual cash flows are calculated:$3,430,000 – $2,250,000 – $1,000,000 =$180,000. Since $180,000 < $1,000,000, all cash flows are claimed by the equity investors and there is no diversion to the trust account.
+30. Continuously increasing default probability (while holding default correlation constant) will most likely have what effect on the credit VaR of mezzanine and equity tranches?
+Equity VaR Mezzanine VaR
+A. Increase Increase then decrease
+B. Increase Decrease then increase
+C. Decrease Increase then decrease
+D. Decrease Decrease then increase
+30. Answer: C
+Increasing the probability of default decreases equity VaR as defaults are more likely, and the equity tranche will suffer writedowns. However, the writedowns are bounded by the thin level of subordination so the variation in losses becomes smaller. Mezzanine tranches behave more like senior bonds at low default levels (increasing VaR) but more like the equity tranche at higher default levels (decreasing VaR)
+31. Which of the following is not an example or element of predatory lending:
+A. Lender makes unaffordable loans based on borrower assets rather than ability to repay
+B. Lender induces borrower to repeatedly refinance in order to collect fees and charge high points
+C. Borrower misrepresents income or employment in mortgage application
+D. Lender engages in deception to conceal true nature of loan; e.g., deceives borrower into thinking loan is fixed-rate when mortgage is actually an adjustable-rate.
+31. Answer: C
+Predatory lending is defined as an activity that involves at least one, and perhaps all three, of the following elements:
+ Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation;
+ Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced ("loan flipping"); or
+ Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.
+32. A hedge fund is considering taking positions in various tranches of a collateralized debt obligation (CDO). The fund’s chief economist predicts that the default probability will decrease significantly and that the default correlation will increase. Based on this prediction, which of the following is a good strategy to pursue?
+A. Buy the senior tranche and buy the equity tranche.
+B. Buy the senior tranche and sell the equity tranche.
+C. Sell the senior tranche and sell equity tranche.
+D. Sell the senior tranche and buy the equity tranche.
+32. Answer: D
+The decrease in probability of default would increase the value of the equity tranche. Also, a default of equity tranche would increase the probability of default of the senior tranche, due to increased correlation, reducing its value. Thus, it is better to go long the equity tranche and short the senior tranche.

info/questions.json

@@ -2,12 +2,444 @@
     {
         "question": "A bank’s risk officer is evaluating climate-related risk drivers that could create financial risk for the bank. The risk officer has classified rising global temperatures and wildfires as acute physical risks. The risk officer is correct with respect to:",
         "options": [
-            "wildfires only.",
-            "rising global temperatures only.",
-            "both wildfires and rising global temperatures.",
-            "neither wildfires nor rising global temperatures."
+            "A wildfires only.",
+            "B rising global temperatures only.",
+            "C both wildfires and rising global temperatures.",
+            "D neither wildfires nor rising global temperatures."
         ],
-        "correct_answer": "wildfires only.",
-        "explanation": "Wildfires are correctly classified as acute physical risks, which relate to extreme weather events. Rising global temperatures should be classified as chronic physical risks, which relate to climate shifts like rising global temperatures and rising sea levels. (LO 99.b)"
+        "correct_answer": "A",
+        "explanation": "Wildfires are correctly classified as acute physical risks, which relate to extreme weather events. Rising global temperatures should be classified as chronic physical risks, which relate to climate shifts like rising global temperatures and rising sea levels. (LO 99.b)",
+        "subject": "Operational Risk",
+        "level": "2"
+    },
+    {
+        "question": "Golin and Delhaise divide credit analysis into four areas according to borrower type:\nI. Consumer credit analysis is the evaluation of the creditworthiness of individual consumers;\nII. Corporate credit analysis is the evaluation of nonfinancial companies such as manufacturers, and nonfinancial service providers;\nIII. Financial institution credit analysis is the evaluation of financial companies including banks and nonbank financial institutions, such as insurance companies and investment funds;\nIV. Sovereign/municipal credit analysis is the evaluation of the credit risk associated with the financial obligations of nations, subnational governments, and public authorities, as well as the impact of such risks on obligations of nonstate entities operating in specific jurisdictions.\nAccording to Golin and Delhaise, each of the following is true about key features of credit analysis with respect to borrower type, except which is not true?",
+        "options": [
+            "A. Individuals (consumers): Credit analysis is amenable to automation and the use of scoring models and statistical tools to correlate risk to limited number of variables",
+            "B. Non-financial corporations: Compared to consumers, tends to be more detailed and \"hands-on\" (i.e. less automated); key variables are likely to include liquidity, cash flow, near-term earnings capacity and profitability, solvency or capital position",
+            "C. Financial Companies: In contrast to corporate (non-financial) credit analysis, qualitative analysis and asset quality are not important, but cash flow is a highly important (a \"key indicator\")",
+            "D. Sovereigns: Includes analysis of country risk, which is primarily political dynamics and state of the economy; and systematic risk, which includes the regulatory regime and the financial system"
+        ],
+        "correct_answer": "C",
+        "explanation": "Credit analysis of financial companies has much in common with corporate credit analysis, but the authors cite two key differences: With respect to financial companies, \"The differences are: The importance of asset quality; The omission of cash flow as a key indicator.\"",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "An analyst has noted that the default frequency in the pharmaceutical industry has been constant at 8% for an extended period of time. Based on this information, which of the following statements is most likely correct for a randomly selected firm following a Bernoulli distribution?",
+        "options": [
+            "I. The cumulative probability that a randomly selected firm in the pharmaceutical industry will default is constant.",
+            "II. The probability that the firm survives for the next 6 years without default is approximately 60%.",
+            "A. I only.",
+            "B. II only.",
+            "C. Both I and II.",
+            "D. Neither I nor I."
+        ],
+        "correct_answer": "B",
+        "explanation": "Statement I is false because the cumulative probability of default increases (i.e., even the highest rated companies will eventually fail over a long enough period). Statement II is true since the probability the firm survives over the next 6 years without default is: (1 – 0.08)^6 = 60.6%.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "The forward probability of default for years one and two is 0.5% and 1.1%, respectively. If the cumulative probability of default for the 3-year period is 4.45%, the forward probability of default for year three is closest to:",
+        "options": [
+            "A. 2.8%",
+            "B. 3.2%",
+            "C. 2.9%",
+            "D. 2.7%"
+        ],
+        "correct_answer": "C",
+        "explanation": "The cumulative probability of default is equal to one minus the probability of surviving to the end of the period without default: C2=1−(1−𝑑𝑑1)(1−𝑑𝑑2)(1−𝑑𝑑3) 0.0445=1−(1−0.005)(1−0.011)(1−𝑑𝑑3) ⇒𝑑𝑑3=2.9%",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "An analyst has gathered the following information about ABC Inc. and DEF Inc. The respective credit ratings are AA and BBB with 1-year CDS spreads of 200 and 300 basis points each. The associated probabilities of default based on published reports are 10% and 20%, respectively. Which of the following statements about the recovery rates is most likely correct?",
+        "options": [
+            "A. The market implied recovery rates are equal.",
+            "B. The market implied recovery rates is higher for ABC.",
+            "C. The market implied recovery rates is lower for ABC.",
+            "D. The loss given default is higher for DEF."
+        ],
+        "correct_answer": "C",
+        "explanation": "The approximation of credit spread = (1 – RR)×(PD). This implies:\nABC: 200bps=(1−RR)×10%, so RR = 80%.\nDEF: 300bps=(1−RR)×20%, so RR = 85%.\nThus, the market implied recovery rate is lower for ABC. Using loss given default terminology, LGD for ABC = 20% and LGD for DEF = 15%.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A firm has issued a single zero-coupon bond that matures in 5 years and has a face value of 100. Assume that the volatility of the firm value is 0.5, that the risk-free rate is 0.04, and that firm value equal to 400. Using the Merton model, what is the value of the bond?",
+        "options": [
+            "A. 75.50",
+            "B. 324.47",
+            "C. 310.40",
+            "D. 89.60"
+        ],
+        "correct_answer": "A",
+        "explanation": "V=400，F=100，r=0.04，σ=0.5，T−t=5 Bond=V×N(−d1)+Fe−r×(T−t)×N(d2) d1,2=ln[V/F×e−r×（T−t）]σ×√T−t±12×σ×√T−t d1=1.978,d2=0.860 Bond=75.50",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "The capital structure of ABC Corporation consists of two parts, one 5 year bond with face value of $100 million and the rest is equity. The current market value of the firm assets is $130 and the expected rate of change of the firm’s value is 25%. The volatility is 30%. The firm’s risk management division estimates the distance to default using Merton model. Given the distance to default, the estimated physical default probability is? (N(1.92) = 97.25%; N(2.58) = 99.52%)",
+        "options": [
+            "A. 2.75%",
+            "B. 12.78%",
+            "C. 12.79%",
+            "D. 30.56%"
+        ],
+        "correct_answer": "A",
+        "explanation": "d2=ln [130/(100e−25%×5)]0.3×√5−0.3×√52=1.92\nThe physical default probability is N(−d2) = 2.75%",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Suppose a firm has two debt issues outstanding. One is a senior debt issue that matures in three years with a principal amount of $100 million. The other is a subordinate debt issue that also matures in three years with a principal amount of $50 million. The annual interest rate is 5% and the volatility of the firm value is estimated to be 15%. If the volatility of the firm value declines in the Merton model then which of the following statements is true?",
+        "options": [
+            "A. If the firm is experiencing financial distress (low firm value), then the value of senior debt will increase while the values of subordinate debt and equity will both decline.",
+            "B. If the firm is not experiencing financial distress (high firm value), then the value of senior debt and subordinate debt and equity will increase.",
+            "C. If the firm is experiencing financial distress (low firm value), then the value of senior debt and subordinate debt will increase while equity values will declines.",
+            "D. If the firm is not experiencing financial distress (high firm value), then the value of senior debt will increase while the values of subordinate debt and equity will both decline."
+        ],
+        "correct_answer": "A",
+        "explanation": "When firms with subordinate debt are experiencing financial distress (low firm values), changes in the value of subordinate will react to changes in the model parameters in the same way as equity. Since equity is valued as a call option in the Merton model, a decline in volatility will reduce the value of equity (and subordinate debt). When firms with subordinate debt are not experiencing financial distress (high firm values), changes in the value of subordinate will react to changes in the model parameters in the same way as senior debt. Since senior debt is valued as the difference in firm value less equity valued as a call option in the Merton model, a decline in volatility will increase the value of senior debt (and subordinate debt).",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following statements regarding the Merton model is true?",
+        "options": [
+            "A. A firm with numerous debt issues that mature at different times is easy to value with the Merton model.",
+            "B. The Merton model assumes a lognormal distribution and constant variance for changes in firm value.",
+            "C. The Merton model is able to predict default because it allows for default surprises (i.e., jumps).",
+            "D. Empirical results indicate that the Merton model is able to predict default better than naïve models for investment grade bonds."
+        ],
+        "correct_answer": "B",
+        "explanation": "Most firms have a variety of debt instruments that mature at different times and have many different coupon rates (i.e., not just zero-coupons as assumed by the Merton model); therefore, Choice A is false. The Merton model assumes that the underlying asset follows a lognormal distribution with constant variance; therefore, Choice B is true. The Merton model does not allow the firm value to jump. Since most defaults are surprises, the inability to have jumps in the firm value in the Merton model makes default too predictable; Therefore, Choice C is false. Jone, Mason, Rosenfeld (1984) report that a naïve model of predicting that debt is riskless works better for investment grade bonds than the Merton model. However, the Merton model works better than the naïve model for debt below investment grade; therefore, Choice D is false.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "The Merton model and the Moody’s KMV model use different approaches to determine the probability of default. Which of the following is consistent with Moody’s KMV model?",
+        "options": [
+            "A. The distance to default is 1.96, so there is a 2.5% probability of default.",
+            "B. The distance to default is 1.96, so there is a 5.0% probability of default.",
+            "C. The historical frequency of default for corporate bonds has been 6%. Updating this with Altman’s Z-score analysis would provide a probability of default that is somewhat different than 6%.",
+            "D. The distance to default is 1.96 and, historically, 1.2% of firms with this characterization have defaulted, so there is a 1.2% probability of default."
+        ],
+        "correct_answer": "D",
+        "explanation": "Moody’s KMV model evaluates the historical frequency of default for firms with similar distances to default and uses this as the probability of default.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Under single-factor model, a firm has a beta of 0.40 and an unconditional default probability of 1%. If we enter a modest economic downturn, such that the value of m = −1.0, what is the conditional default probability? N(2.1) = 0.9820",
+        "options": [
+            "A. 1.0%",
+            "B. 1.8%",
+            "C. 2.5%",
+            "D. 2.8%"
+        ],
+        "correct_answer": "B",
+        "explanation": "Conditional default has a mean of 0.40×(−1) = −0.40 and a volatility of√1−0.42=0.92.The loss threshold is −2.33. Therefore the conditional default probability is: Φ􁉀−2.33+0.40.92􁉁=1.8%",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Given a hazard rate of 0.15, find the probability when a company defaults in year two after surviving the first year.",
+        "options": [
+            "A. 0.1393",
+            "B. 0.2592",
+            "C. 0.7408",
+            "D. 0.8607"
+        ],
+        "correct_answer": "A",
+        "explanation": "T\nCumulative PD\nSurvival Probability\nPD (t, t+1)\nConditional PD Given Survival Until Time t\n1\n1 – 𝑒𝑒−0.15 = 0.1393\n1 – 0.1393 = 0.8607\n0.1393\n2\n1 – 𝑒𝑒−0.15×2 =0.2592\n1 – 0.2592 = 0.7408\n0.2592 – 0.1393 = 0.1199\n0.1199/0.8607 = 0.1393",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following statements regarding counterparty credit risk are correct?",
+        "options": [
+            "I. Expected positive exposure is the highest expected exposure over a specified interval.",
+            "II. Wrong-way exposures are positively correlated with the counterparty’s credit quality.",
+            "III. Credit triggers are early settlement agreements that require counterparties to settle and terminate trades if the credit rating of a party falls below a specified level.",
+            "IV. Right-way exposures are negatively correlated with the counterparty’s credit quality.",
+            "V. Cross-product netting is a provision that allows counterparties to net payments across different products.",
+            "VI. Collateral agreements require that specified amounts of liabilities be transferred to counterparty if exposures exceed a specified threshold.",
+            "A. III and V only.",
+            "B. I, III, and V.",
+            "C. I, II, and IV.",
+            "D. III, V, and VI."
+        ],
+        "correct_answer": "A",
+        "explanation": "Credit triggers are early settlement agreements that require counterparties to settle and terminate trades if the credit rating of a party falls below a specified level. Cross-product netting is a provision that allows counterparties to net payments across different products. Expected positive exposure is the average expected exposure over a specified interval. Wrong-way exposures are negatively correlated with the counterparty’s credit quality Right-way exposures are positively correlated with the counterparty’s credit quality. Collateral agreements require that specified amounts of assets be transferred to a counterparty if exposures exceed a specified threshold.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following security types correspond to the PFE graphs below?",
+        "options": [
+            "A. Loan",
+            "B. Interest Rate Swap",
+            "C. Currency Swap",
+            "D. Bond"
+        ],
+        "correct_answer": "C",
+        "explanation": "For currency swap, the majority of the exposure results from the uncertainty regarding the final notional value payment associated with FX rate risk.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A risk manager needs a quick calculation of the BCVA on a swap. Assume inputs are as follows: EPE = 5%, ENE = 3%, counterparty credit spread = 300bps, financial institution credit spread = 200 bps. Compute BCVA from the perspective of the financial institution.",
+        "options": [
+            "A. -1",
+            "B. 1",
+            "C. 9",
+            "D. -9"
+        ],
+        "correct_answer": "C",
+        "explanation": "From the perspective of the financial institution: EPE×counterparty credit spread−ENE×institution credit sprea =5%×300−3%×200=9bps\nThis is what the financial institution may charge the counterparty for overall counterparty risk.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following statements regarding wrong-way risk and right-way risk is correct?",
+        "options": [
+            "A. A long put option is subject to wrong-way risk if both risk exposure and counterparty default probability decrease.",
+            "B. A long call option experiences right-way risk if the interaction between risk exposure and counterparty default probability produces an overall decline in counterparty risk.",
+            "C. Declining local currency can decrease the position gain in a foreign currency transaction, while increasing risk exposure of the counterparty.",
+            "D. The 2007-2008 credit crisis provides an example of wrong-way risk from the perspective of a long who had sold credit default swaps (CDSs) as protection against bond issuers’ default."
+        ],
+        "correct_answer": "B",
+        "explanation": "A long call option experiences right-way risk if risk exposure and counterparty default probability results in decreased counterparty risk. A long put option is subject to wrong-way risk if both risk exposure and counterparty default probability increase. Declining local currency can increase the position gain in a foreign currency transaction, while increasing counterparty risk exposure. The 2007-2008 credit crisis provides an example of wrong-way risk from the perspective of a long who had bought CDSs as protection against bond issuers’ default.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Consider two portfolios. One with USD 100 million credit exposure to a single B-rated counterparty. The second with USD 100 million on credit exposure split evenly between 50 B-rated counterparties. Assume that default probabilities and recovery rates are the same for all B-rated counterparties. Which of the following is correct?",
+        "options": [
+            "A. The expected loss of the first portfolio is greater than the expected loss of the second portfolio AND the unexpected loss of the first portfolio is greater than the unexpected loss of the second portfolio.",
+            "B. The expected loss of the first portfolio is greater than the expected loss of the second portfolio AND the unexpected loss of the first portfolio is equal to the unexpected loss of the second portfolio.",
+            "C. The expected loss of the first portfolio is equal to the expected loss of the second portfolio AND the unexpected loss of the first portfolio is equal to the unexpected loss of the second portfolio.",
+            "D. The expected loss of the first portfolio is equal to the expected loss of the second portfolio AND the unexpected loss of the first portfolio is greater than the unexpected loss of the second portfolio."
+        ],
+        "correct_answer": "D",
+        "explanation": "There’s diversification effect in unexpected loss.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Suppose there is a $1,000,000 portfolio with n credits that each have a default probability, π = 2% and a zero recovery rate. The default correlation is 0 and n = 1,000. There is a probability of 28 defaults at the 95th percentile based on the binomial distribution with the parameters of n = 1,000 and π = 0.02. What is the credit VaR at the 95% confidence level based on these parameters?",
+        "options": [
+            "A. $7,000",
+            "B. $8,000",
+            "C. $9,000",
+            "D. $10,000"
+        ],
+        "correct_answer": "B",
+        "explanation": "The 95th percentile of the credit loss distribution is $28,000 (28×$1,000,000/1,000). The expected loss is $20,000 ($1,000,000×0.02). The credit VaR is then $8,000 ($28,000 − $20,000).",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Suppose a portfolio has a notional value of $1,000,000 with 20 credit positions. Each of the credits has a default probability of 2% and a recovery rate of zero. Each credit position in the portfolio is an obligation from the same obligor, and therefore, the credit portfolio has a default correlation equal to 1. What is the credit value at risk at the 99% confidence level for this credit portfolio?",
+        "options": [
+            "A. $0",
+            "B. $1,000",
+            "C. $20,000",
+            "D. $980,000"
+        ],
+        "correct_answer": "D",
+        "explanation": "With the default correlation equal to 1, the portfolio will act as if there is only one credit. Viewing the portfolio as a binomial distributed random variable, there are only two possible outcomes for a portfolio acting as one credit. The portfolio has a 2% probability of total loss and a 98% probability of zero loss. Therefore, with a recovery rate of zero, the extreme loss given default is $1,000,000. The expected loss is equal to the portfolio value times π and is $20,000 in this example. The credit VaR is defined as the quantile of the credit loss less the expected loss of the portfolio. At the 99% confidence level, the credit VaR is equal to $980,000.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Bank A, which is AAA rated, trades a 10-year interest rate swap (semi-annual payments) with Bank B, which is rated A-. Because of Bank B's poor credit rating, Bank A is concerned about the 10-year exposure it is going to run because of the swap deal. Which of the following measures help mitigate Bank A's credit exposure to Bank B?",
+        "options": [
+            "I. Negotiate a CSA with Bank B and efficiently manage the collateral management system",
+            "II. Execute the swap deal as a reset swap wherein the swap will be marked to market every six months",
+            "III. Execute the swap deal with a break clause in the fifth year",
+            "IV. Decrease the frequency of coupon payments from semi-annual to annual",
+            "A. I only",
+            "B. IV only",
+            "C. I, II, III and IV",
+            "D. I, II and III"
+        ],
+        "correct_answer": "D",
+        "explanation": "'I' is correct. Negotiating a CSA and getting collateral from the counterparty is an effective way of mitigating credit exposure.\n'II' is correct. In a reset swap since the swap is marked to market every period, the credit exposure we run is only for that period i.e. till the next reset; this implies lesser exposure.\n'III' is correct. A break clause is always useful since it gives the counterparties an opportunity to assess whether they want to continue for the rest of the term of the swap.\n'IV' is incorrect. Decreasing the frequency of payments increases the credit exposure rather than decreasing it. This is because, more the time for the next payment, greater are the chances for the market rates to move in one counterparty's favor, thereby increasing its credit exposure to the other counterparty.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following would not generally decrease credit risk?",
+        "options": [
+            "A. Entering into an interest-rate swap with a counterparty",
+            "B. Signing a legally-binding netting agreement covering a portfolio of OTC derivative trades with a counterparty",
+            "C. Clearing an existing trade through a clearing house",
+            "D. Purchasing a credit derivative from a AAA-rated institution that pays USD 5 million if a bond defaults"
+        ],
+        "correct_answer": "A",
+        "explanation": "A is correct. Entering into an interest rate swap causes the firm to be exposed to the credit risk of the swap counterparty.\nB is incorrect. Netting agreements are one of the most powerful ways for controlling exposures. The purpose of these agreements is to provide for netting of payments across a set of contracts.\nC is incorrect. Executing a trade through a clearing house will generally decrease credit risk. The counterparty to the contract is now the clearinghouse. Most clearinghouses are well capitalized and their risk of default is effectively zero.\nD is incorrect. Credit derivatives are contracts that pass credit risk from one counterparty to another. A long position in the credit derivative will help to decrease credit risk as it pays USD 5 million if the bond defaults.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A 2-year credit default swap (CDS) specifying physical delivery defaults at the end of two years. If the reference asset is a $200 million, 8.0% ABC corporate bond, and the CDS spread is 125 basis points, the buyer of the CDS will:",
+        "options": [
+            "A. Receive payments of 800 basis points for the next two years.",
+            "B. Receive a payment of $167.5 million.",
+            "C. Deliver the bond and receive a payment of $200 million.",
+            "D. Continue to receive payments of 675 basis points for the next two years."
+        ],
+        "correct_answer": "C",
+        "explanation": "If the swap specifies physical delivery, the buyer of the swap will deliver the reference obligation to the seller and receive the par value of the obligation.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "You are currently long $10,000,000 par value, 8% XYZ bonds. To hedge your position, you must decide between credit protection via a 5-year CDS with 60bp annual premiums or digital swap with 50% payout with 50bp annual premiums. After one year, XYZ has defaulted on its debt obligations and currently trades at 60% of par. Which of the following statements is true?",
+        "options": [
+            "A. The contingent payment from the protection buyer to the protection seller is greater under the single-name CDS than the digital swap.",
+            "B. The contingent payment from the protection buyer to the protection seller is less under the single-name CDS than the digital swap.",
+            "C. The contingent payment from the protection seller to the protection buyer is greater under the single-name CDS than the digital swap.",
+            "D. The contingent payment from the protection seller to the protection buyer is less under the single-name CDS than the digital swap."
+        ],
+        "correct_answer": "D",
+        "explanation": "Choices A and B can be eliminated because payments in default are made from protection seller to protection buyer. The payoff from the digital swap will be 50% of par value while the payoff from the single name will be 40% (i.e., 1 – 0.6) of par value.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A six-year CDS on an AA-rated issuer is offered at 150bp with semiannual payments while the yield on a six-year semiannual coupon bond of this issuer is 8%. There is no counterparty risk on the CDS. The annualized LIBOR rate paid every six months is 4.6% for all maturities. Which strategy would exploit the arbitrage opportunity? How much would your return exceed LIBOR?",
+        "options": [
+            "A. Buy the bond and the CDS with a risk-free gain of 1.9%.",
+            "B. Buy the bond and the CDS with a risk-free gain of 0.32%.",
+            "C. Short the bond and sell CDS protection with a risk-free gain of 4.97%.",
+            "D. There is no arbitrage opportunity as any apparent risk-free profit is necessarily compensation for being exposed to the credit risk of the issuer."
+        ],
+        "correct_answer": "A",
+        "explanation": "Because LIBOR is flat, the fixed-coupon yield is also 4.6%, creating a spread of 800 – 460 = 340bp on the bond. Going long the bond and short credit via buying the CDS yields an annual profit of 340 – 150 = 190bp.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "In pricing a first-to-default credit basket swap, which of the following is true, all else being equal?",
+        "options": [
+            "A. The lower the correlation between the assets of the basket, the lower the premium.",
+            "B. The lower the correlation between the assets of the basket, the higher the premium.",
+            "C. The higher the correlation between the assets of the basket, the higher the premium.",
+            "D. The correlation between the assets has no impact in the premium of a first-to- default credit basket swap."
+        ],
+        "correct_answer": "B",
+        "explanation": "The lower the correlation between the assets of the basket, the higher the premium. In the case of a first-to-default swap, a credit event occurs the first time any of the entities defaults. This swap provides default protection against losses related to this first default, but not to any subsequent defaults. Thus, the question is whether the level of correlation between assets of the basket increases or decreases the likelihood of the triggering event. If the correlation between the assets in a credit basket swap is lower, the basket would be exposed to greater default risk. For example, the basket contains assets from different sectors, then the basket would be exposed to the default risk of each and every sector in the basket. If the basket only contains assets from one sector, then the correlation is higher, and the default risk is lower.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Bank One has made a $200 million loan to a software company at a fixed rate of 12 percent. The bank wants to hedge its exposure by entering into a Total Return Swap with a counterparty, Interloan Co., in which Bank One promises to pay the interest on the loan plus the change in the market value of the loan in exchange for LIBOR plus 40 basis points. If after one year, the market value of the loan has decreased by 3 percent and LIBOR is 11 percent, what will be the net obligation of Bank One?",
+        "options": [
+            "A. Net receipt of $4.8 million",
+            "B. Net payment of $4.8 million",
+            "C. Net receipt of $5.2 million",
+            "D. Net payment of $5.2 million"
+        ],
+        "correct_answer": "A",
+        "explanation": "Bank One would be due: ($200 million)×(0.11 + 0.0040)= $22.8 million and would owe: ($200 million)×(0.12) + ($200 million)×(−0.03)= $18.0 million\nThe net obligation of Bank One would be $22.8 million – S18 million = $4.8 million.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "If a pool of mortgage loans begins the month with a balance of $10,500,000, has a scheduled principal payment of $54,800, and ends the month with a balance of $9,800,000, what is the CPR for this month?",
+        "options": [
+            "A. 6.177%",
+            "B. 42.240%",
+            "C. 53.472%",
+            "D. 66.670%"
+        ],
+        "correct_answer": "C",
+        "explanation": "We use the following formulas:SMM=prepaymentbeg.bal−scheduled principal payment and\n(1−SMM)12=(1−CPR)\nPrepayment = actual payment − scheduled payment = ($10,500,000 − $9,800,000) − $54,800 = $700,000 − $54,800 = $645,200.\nSo: $645,200/($10,500,000−$54,800)=0.06177 and CPR=1−(1−0.06177)12=0.5347=53.47%",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A pass-through mortgage-backed security (MBS) with a weighted average maturity (WAM) of 30 months has an original principle balance of $2.0 billion. If the valuation model assumes a 300% PSA prepayment speed, which is nearest to the first month's prepaid (not scheduled) principal?",
+        "options": [
+            "A. $519,000",
+            "B. $833,000",
+            "C. $1.00 million",
+            "D. $2.15 million"
+        ],
+        "correct_answer": "C",
+        "explanation": "300%PSA=3×CPR=3×0.2%=0.6% SMM=1−(1−0.6%)112=0.05014% 0.05014%×2,000,000,000=1,002,760",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "King Motors Acceptance Corporation (KMAC), the finance arm of King Motors, issues an auto-loan asset-backed security that consists of a senior tranche, denoted Tranche A in the amount of $50 million and an interest payment of 5 percent, and two subordinated tranches, denoted Tranches X and Z respectively, each with a face amount of $35 million. Tranche X pays investors annual interest at a rate of 6.5 percent while Tranche Z pays investors annual interest at a rate of 7.5 percent. Which of the following methods of credit support would NOT affect the credit quality of subordinated Tranche X?",
+        "options": [
+            "A. The total amount of the auto loans that make up the asset-backed issue is $125 million.",
+            "B. The weighted average interest rate on the auto loans making up the pool is 6.4 percent.",
+            "C. Any defaults on the part of King Motor’s customers will be first absorbed by Tranche Z.",
+            "D. KMAC has a reserve in the amount of $10 million that will remain on KMAC’s balance sheet."
+        ],
+        "correct_answer": "D",
+        "explanation": "An investor’s claim when purchasing an ABS is solely with the ABS and no longer with the originator. The fact that KMAC has $10 million set aside means nothing for the ABS issue if it remains on KMAC’s balance sheet and is not part of the ABS issue. The other answer choices all describe forms of credit support that will support at least Tranches X and A, if not all 3 tranches. By having Tranche Z be subordinate to Tranche X, Tranche X has additional support. Also, loans of $125 million are used to back asset-backed securities worth ($50 + $35 + $35) = $120 million, which means the issue is over collateralized. The weighted average interest rate paid on the securities is approximately 6.2%. If the weighted average interest rate on the loans that make up the pool is 6.4% that means there is an excess spread between the loans and securities that also provides support for the entire issue.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Assume there are 100 identical loans with a principal balance of $500,000 each. Based on a credit analysis, a 300 basis point spread is applied to the borrowers. LIBOR is currently 4% and the coupon rate will reset annually. The senior, junior, and equity tranches are 75%, 20%, and 5% of the pool, respectively. The spreads on the senior and mezzanine tranches are 2% and 6%. Excess cash flow is diverted to trust account above $1,000,000. Assume the default rate is 2%. What are the cash flows to the mezzanine and trust account in the first period?",
+        "options": [
+            "Mezzanine Trust account",
+            "A. $1,000,000 $0",
+            "B. $1,000,000 $180,000",
+            "C. $2,250,000 $200,000",
+            "D. $2,250,000 $250,000"
+        ],
+        "correct_answer": "A",
+        "explanation": "The interest rate on the loans = 4%(LIBOR)+3%(spread) = 7%. Therefore,\nthe total collateral cash flows in the first period = 100×$500,000×7%×(1 – 0.02) = $3,430,000. The senior tranche receives$50million×0.75×(4%+2%)=$2,250,000. Similarly, the mezzanine tranche receives$50million×0.20×(4%+6%)=$1,000,000. Next, the residual cash flows are calculated:$3,430,000 – $2,250,000 – $1,000,000 =$180,000. Since $180,000 < $1,000,000, all cash flows are claimed by the equity investors and there is no diversion to the trust account.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Continuously increasing default probability (while holding default correlation constant) will most likely have what effect on the credit VaR of mezzanine and equity tranches?",
+        "options": [
+            "Equity VaR Mezzanine VaR",
+            "A. Increase Increase then decrease",
+            "B. Increase Decrease then increase",
+            "C. Decrease Increase then decrease",
+            "D. Decrease Decrease then increase"
+        ],
+        "correct_answer": "C",
+        "explanation": "Increasing the probability of default decreases equity VaR as defaults are more likely, and the equity tranche will suffer writedowns. However, the writedowns are bounded by the thin level of subordination so the variation in losses becomes smaller. Mezzanine tranches behave more like senior bonds at low default levels (increasing VaR) but more like the equity tranche at higher default levels (decreasing VaR)",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "Which of the following is not an example or element of predatory lending:",
+        "options": [
+            "A. Lender makes unaffordable loans based on borrower assets rather than ability to repay",
+            "B. Lender induces borrower to repeatedly refinance in order to collect fees and charge high points",
+            "C. Borrower misrepresents income or employment in mortgage application",
+            "D. Lender engages in deception to conceal true nature of loan; e.g., deceives borrower into thinking loan is fixed-rate when mortgage is actually an adjustable-rate."
+        ],
+        "correct_answer": "C",
+        "explanation": "Predatory lending is defined as an activity that involves at least one, and perhaps all three, of the following elements:\n Making unaffordable loans based on the assets of the borrower rather than on the borrower's ability to repay an obligation;\n Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (\"loan flipping\"); or\n Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.",
+        "subject": "Credit risk",
+        "level": "2"
+    },
+    {
+        "question": "A hedge fund is considering taking positions in various tranches of a collateralized debt obligation (CDO). The fund’s chief economist predicts that the default probability will decrease significantly and that the default correlation will increase. Based on this prediction, which of the following is a good strategy to pursue?",
+        "options": [
+            "A. Buy the senior tranche and buy the equity tranche.",
+            "B. Buy the senior tranche and sell the equity tranche.",
+            "C. Sell the senior tranche and sell equity tranche.",
+            "D. Sell the senior tranche and buy the equity tranche."
+        ],
+        "correct_answer": "D",
+        "explanation": "The decrease in probability of default would increase the value of the equity tranche. Also, a default of equity tranche would increase the probability of default of the senior tranche, due to increased correlation, reducing its value. Thus, it is better to go long the equity tranche and short the senior tranche.",
+        "subject": "Credit risk",
+        "level": "2"
     }
 ]