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Corporate Risk Management Exam

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Corporate Risk Management Exam
Corporate Risk Management BUFN 754
Example Examination
Fall 2013

NAME:

I pledge on my honor that I have not given or received any unauthorized assistance on this examination

Please answer all questions in the space provided. Point weights are as indicated. Formulas are provided in the back of the exam. Good Luck!

1. A firm has assets of $1M invested in 30-year, 10% coupon Treasury bonds selling at par and whose duration is 9.94 years. It has liabilities of $900,000 financed through a two-year, 7.25% coupon note selling at par. Using the information above, what is the impact on equity values if all interest rates rise by 20bps; i.e., R/(1+R) = +.002? (10 points)

2. This bank wishes to hedge its interest rate risk exposure with 10-year Treasury bond futures. A 10-year, 5% coupon Treasury bond (basis for the futures contract) has a duration of 7.5 years. If 10-year Treasury bond futures contracts currently are selling for $102,000 per contract, what should the bank do to hedge its interest rate risk? We also know that Treasury futures prices move 1.5% for every 1% change in spot Treasury prices. (10 points)

3. Using the information in question 1 again, assume the bank wishes to hedge by using put options on Treasury bonds where the underlying security has a duration of 6 years. Put option prices decline $.4 for every $1 move in T bond prices. The current market value of T bonds is $99,000 and assume market interest rates are at 8%. How many put option contracts are needed to hedge the interest rate risk exposure? Do you go long or short? (10 points)

4. Using the Merton default model we determine that the risk-neutral probability of default for a bond with a maturity of 6 years is 35% and the expected recovery rate is 50%. Corresponding 1, 6, and 30 year Treasury yields are 1, 2, and 3%, respectively. What is the theoretical credit

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