Description
please understand the question before you solve it. I will upload two file. one is an excel file and the other is an pdf. solve the questions from the pdf file into the excel file. please let me know if you have any questions
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Explanation & Answer
Here is the solution. It looks like the spelling should be tranches not traunches. I did not change it because it has the same spelling at all places.
1. If the probability of default for bond A2 increases to from 0.05 to 0.15 (holding
bond A1's default probability at 0.05 and the dependency multiplier = 1 ):
a. What happens to the values of the two bonds?
The Expected value changes for the bond A2 as this becomes riskier and chance
of the pay out is decreased.
Hence, the new expected value of A2 = $1000 * (1 – 0.15) = $850 (G21).
The present value also changes, calculated at a ROR (rate of return) = 5%
Present value of the A2 = $850 / 1.05 = $809.52 (H21)
The values doesn’t change for the bond A1.
b. What happens to the values of senior and junior traunched bonds?
The probability of the of the joint loss of both the Bond’s together increases from
0.0025 (0.05 * 0.05) to 0.0075 (0.05 * 0.15). This affects the joint probabilities of
default and pay outs.
The values of both the senior and junior traunches are decreased.
Expected Values
Present Values (Calculated at 5%
rate of return)
Payout
*
(1
–
prob
of
both
bonds
defaulting)
Expected value of Senior Traunch / (1 + rate
Senior
= $1000 * (1 – 0.0075)
of return)
Traunch = $992.5 (G26)
= $992.5 / 1.05
Juni...