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# Hull: Options, Futures, and Other Derivatives, Ninth Edition

## Chapter 24: Credit Risk

Multiple Choice Test Bank: Questions
1. Suppose that the cumulative probability of a company defaulting by years
one, two, three and four are 3%, 6.5%, 10%, and 14.5%, respectively. What
is the probability of default in the fourth year conditional on no earlier
default?
A. 4.5%
B. 5.0%
C. 5.5%
D. 6.0%
2. Which of the following is usually used to define the recovery rate of a bond?
A. The value of the bond immediately after default as a percent of its face
value
B. The value of the bond immediately after default as a percent of the
sum of the bonds face value and accrued interest
C. The amount finally realized by a bondholder as a percent of face value
D. The amount finally realized by a bondholder as a percent of the sum of
the bonds face value and accrued interest
3. Which of the following is true?
A. Risk neutral default probabilities are usually much lower than real
world default probabilities
B. Risk neutral default probabilities are usually much higher than real
world default probabilities
C. Risk neutral and real world probabilities must be close to each other if
there are to be no arbitrage opportunities
D. Risk-neutral default probabilities cannot be calculated from CDS
4. A hazard rate is 1% per annum. What is the probability of a default during the
first two years?
A. 2.00%
B. 2.02%
C. 1.98%
D. 1.96%
5. Which of the following is true
A. The default probability per year for a company always increases as we
B. The default probability per year for a company always decreases as we
C. Sometimes A is true and sometimes B is true
D. The default probability per year is roughly constant for most
companies

## 6. Which of the following is true

A. Conditional default probabilities are at least as high as unconditional
default probabilities
B. Conditional default probabilities are at least as low as unconditional
default probabilities
C. Conditional default probabilities are sometimes lower and sometimes
higher than unconditional default probabilities.
D. There is no difference between conditional and unconditional default
probabilities because a company can only default once.
7. If a companys five year credit spread is 200 basis points and the recovery
rate in the event of a default is estimated to be 20% what is the average
hazard rate per year over the five years
A. 0.4%
B. 1.2%
C. 1.8%
D. 2.5%
8. Which of the following is true
A. Recovery rates are lower for investment grade companies
B. Recovery rates are higher for non-investment grade companies
C. Recovery rates are negatively correlated with default rates
D. Recovery rates are positively correlated with default rates
9. Which of the following is true
A. The asset swap spread is a measure of excess of the bond yield over
the OIS rate
B. The asset swap spread is a measure of excess of the bond yield over
the LIBOR/swap rate
C. An asset swap exchanges the actual return on the asset for LIBOR plus
D. None of the above
10.To be investment grade, a company has to have a credit rating of
A. AA or better
B. A or better
C. BBB or better
D. BB or better
11.In the Gaussian copula model which of the following is true
A. The time to default for a company is assumed to be normally
distributed.
B. The time to default for a company is assumed to be lognormally
distributed
C. The time to default for a company is transformed to a normal
distribution
D. The time to default for a company is transformed to a lognormal
distribution

## 12.Which of the following is true

A. Netting always leads to a reduction in a companys exposure to a
counterparty
B. Netting always leads to a companys exposure to a counterparty either
staying the same or going down
C. Netting always increases a companys exposure to a counterparty
D. Netting can increase or reduce the exposure
13.Which of the following is true
A. Downgrade triggers are particularly valuable if they are widely used by
a companys
counterparties
B. Downgrade triggers become less valuable if they are widely used by a
companys counterparties
C.
Downgrade triggers are useless because their impact is always
anticipated by the market
D.
Downgrade triggers are a two-edged sword. If company A has a
company B then company B has a
14.Which of the following is true of Mertons model:
A. The equity is a call option on the assets
B. The assets are a call option on the debt
C. The debt is a call option on the equity
D. The equity is a call option on the debt
15.Which of the following is true of Mertons model:
A. The strike price is the market value of the debt
B. The strike price is the market value of the equity
C. The strike price is the book value of the equity
D. The strike price is the face value of the debt
16.Which of the following is true
A. The Gaussian copula model assumes that the defaults of different
companies are independent.
B. The Gaussian copula model assumes that defaults, conditional on the
value of a factor , are independent.
C. The Gaussian copula model assumes that the number of defaults is
normally distributed.
D. None of the above.
17.A derivatives dealer has a single transaction with a company which is a long
position in a five-year option. The Black-Scholes-Merton value of the option is
\$6. Suppose that the credit spread on five-year bonds issued by the company
is 100 basis points. What is the dealers CVA per option purchased from the
counterparty?
A. \$0.19
B. \$1.19
C. \$0.29

D. \$1.29
18.Which of the following is true
A. A derivative dealers CVA is the counterpartys DVA and vice versa
B. Collateral posted by the counterparty reduces CVA
C. Collateral posted by the dealer reduces DVA
D. All of the above

19.The credit spreads for a counterparty for 5 and 6 years are 2% and 2.2%
respectively. The recovery rate is 60%. What is closest to the unconditional
default probability for the sixth year?
A. 0.04
B. 0.05
C. 0.06
D. 0.07
20.Which of the following is true of Creditmetrics when it is used to calculate
credit VaR
A. Creditmetrics takes defaults but not downgrades into account
B. Creditmetrics takes downgrades but not defaults into account
C. Creditmetrics considers neither defaults nor downgrades
D. Creditmetrics considers both defaults and downgrades