Week 5 - Credit Risk

Question 1

Conditional DP is…

Answer 1

…the default probability over a short period conditional no earlier default (aka hazard rate)

Question 2

!!Why isn’t the average hazard rate equal to the conditional PD?

Answer 2

If we take the conditional PD over a longer time span, it will be further and further away from the avg hazard rate.

Question 3

What is CDS spread ?

Answer 3

CDS spread is the total amount paid per year, as a % of the notional principal, to buy the CDS. It is paid for the life of the contract or until default.

Question 4

Unconditional default probability is…

Answer 4

…the probability of default as seen at time zero (table)

Question 5

Claim: We should use risk-neutral estimates for valuing credit derivatives and estimating the present value of the cost of default

Answer 5

True

Question 6

What estimates do we use for calculating credit VaR and scenario analysis?

Answer 6

We should use real-world estimates for calculating credit VaR and scenario analysis

Question 7

The expected cost of default is equal to …

Answer 7

the risk-free price of the bond - market price of the bond (using bond yield for discounting)

Question 8

The recovery rate for a bond is…

Answer 8

… the price at which it trades one month after default as a % of face value