NYU-Stern School

C15.0021.002 - Fall 2001

Professor Sinan Cebenoyan

Exam 2 NAME:………………………………

11/13/2001 SS# last 4 digits :……….……….

Part 1. Circle the right answer. All questions are worth 0.5 points.

T F 1. Measuring market risk is important, as it allows management to generously reward the traders who take on the highest risks in the hope of generating the highest returns.

T F 2. Calculating the risk of a multi-asset trading portfolio requires the consideration of the correlations of returns between the different assets.

T F 3. The error from using duration to estimate the new price of a fixed-income security will be greater as the amount of convexity increases.

T F 4. JPM's RiskMetrics Model focuses on the computation of Daily Earnings at Risk as a percentage of total earnings for the day.

T F 5. Value at Risk takes into consideration the time it takes to unwind a position.

T F 6. In Historic (Back Simulation) Model, we do not make assumptions about the distributions but we still need to calculate correlations.

T F 7. One problem with Back Simulation is that if you go back too far in time to gather more data the relevance of these observations may be suspect.

T F 8. The BIS standardized framework for Market Risk when looking at fixed income portfolios acknowledges that while all fixed income securities will have Specific Risk not all will have General Market Risk.

T F 9. Credit rationing is a form of price rationing.

T F 10. It is better for a bank to make shorter-term loans as floating-rate contracts than longer-term loans.

T F 11. Compensating balances are a proportion of a loan that a borrower cannot actively use for expenditures.

T F 12. Qualitative Default risk models rely mostly on publicly available borrower-specific information on the quality of borrowers.

T F 13. If p is the probability of repayment, then (1-p) must be the probability of default.

T F 14. A Loan Migration Matrix (or transition matrix) seeks to reflect the historic experience of a pool of loans in terms of their credit-rating migration over time.

T F 15. International loan rather than bond finance makes rescheduling less likely.

T F 16. Of the variables used in statistical risk-scoring models of sovereign country risk that we studied, Investment Ratio is the only one with an ambiguous effect (+ or -).

T F 17. Domestic Money Supply Growth will negatively affect rescheduling risk, as the country will have larger amounts of money to pay the loans back.

T F 18. Brady Bonds are another name for Sovereign Bonds.

Part 2. To receive partial credit you must show ALL Work.

1. Gotcha Bank has a position in a five-year zero coupon bond with a face value of $1,469,328. The current yield to maturity of the bond is 8%. The historical mean change in daily yields is 0.0 percent and the standard deviation is 12 basis points. Assume that we plan for a maximum of 5 percent (on a two-tailed test) change in yields as maximum adverse daily move( we use 1.65 s). What is the DEAR of this bond? (4 points)

2. The estimated DEAR of the stock portfolio of a bank is $3 million, and the DEAR of its bond portfolio is $2 million.

a)  If the correlation coefficient between the two is 0.8, what is the DEAR of the overall portfolio?(2 points)

b)  If the correlation coefficient between the two is -1.0, what is the DEAR of the overall portfolio? (1 point)

3. A bank is planning to make a loan of $5,000,000 to a firm in the telecom industry. It expects to charge a servicing fee of 60 basis points. The loan has a maturity of 8 years with a duration of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 percent. Assume the bank has estimated the risk premium on the telecom sector to be approximately 4.2 percent, based on two years of historical data. The current market interest rate for loans in this sector is 12 percent. Using the RAROC model, estimate whether the bank should make the loan?(4 points)


4. A bank is in the process of renegotiating a loan. The principal outstanding is $50 million and is to be paid back in two installments of $25 million each, plus interest of 8 percent. The new terms will stretch the loan out to 5 years with no principal payments except for interest payments of 6 percent for the first three years. The principal will be paid in the last two years in payments of $25 million along with the interest. The cost of funds for the bank is 6 percent for both the old loan and the renegotiated loan. An up-front fee of 1 percent is to be included for the renegotiated loan. Calculate the concessionality. (4 points)

5. Consider a 4-year, $1,000 par value, 7 percent, annual coupon bond that is trading to yield 7 percent. What is the convexity factor (CX) for this bond? (2 points)