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There are two bonds in a portfolio, each with a market value of $50m. The probability of default of the two bonds are 0.03 and 0.08 respectively, over a one year horizon. If the probability of the two bonds defaulting simultaneously is 1.4%, what is the default correlation between the two?
Suggested Answer: D
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The change in the price of a security that follows a Weiner process is determined by its standard deviation and expected return. To get the price itself, we need to add this change in price to the current price. Therefore the future price in a Weiner process is determined by all three of current price, expected return and standard deviation.
34 comments · newest first
CA
Catalina
11 months ago
40% correlation sounds way too high for these numbers!
BU
Burma
11 months ago
I'm leaning towards option D, seems reasonable.
LU
Luis
11 months ago
Surprised the simultaneous default is only 1.4%!
MA
Marg
11 months ago
I think the correlation is definitely not 100%.
AR
Armanda
12 months ago
The default probabilities are 0.03 and 0.08.
RE
Renea
12 months ago
I vaguely recall that if the default probabilities are independent, the correlation would be 0%. So maybe option A could be the answer, but I'm not completely confident.
NO
Noe
12 months ago
I feel like the correlation should be low since the individual default probabilities are relatively low, but the simultaneous default probability is throwing me off a bit.
DU
Dulce
1 year ago
This question seems similar to one we practiced where we had to find the correlation based on joint probabilities. I think I might lean towards option D, but I need to double-check my calculations.
DO
Dorcas
1 year ago
I remember we discussed default correlation in class, but I'm not entirely sure how to calculate it from the probabilities given.
MA
Mari
1 year ago
Okay, let's see. Coordinating related projects, delivering business products, delivering outcomes and benefits, and aligning to strategic objectives - those all sound like typical programme goals to me. I'll have to really analyze these to figure out which one doesn't fit.
KR
Kristeen
1 year ago
Hmm, this seems like a tricky one. I'll need to carefully review the DataRaptor Load settings and the JSON data being sent from the OmniScript to identify any mismatches or issues.
FL
Floyd
1 year ago
I'm a bit confused on this one. I know a weighting system is used to evaluate proposals, but I'm not sure if that falls under Selecting sellers or another area. I'll have to review my notes to be sure.
JE
Jerilyn
1 year ago
Ah, the classic 'default correlation' question. I bet the answer is going to be a bit counterintuitive.
CA
Candida
1 year ago
Wait, what's the probability of two bonds defaulting simultaneously? That seems like a key piece of information here.
BE
Beckie
1 year ago
C) 40%
TA
Tawna
1 year ago
B) 100%
SH
Shayne
1 year ago
C) 40%
JE
Jerrod
1 year ago
A) 0%
RO
Roxane
1 year ago
B) 100%
CA
Caprice
1 year ago
A) 0%
DO
Dominga
1 year ago
Alright, time to put on my thinking cap. This might require a bit of creative problem-solving.
AS
Ashleigh
1 year ago
C) 40%
CE
Celestina
1 year ago
B) 100%
MO
Mona
1 year ago
A) 0%
SH
Sherrell
1 year ago
I feel like I've seen a question like this before. Time to put my finance knowledge to the test!
HI
Hildegarde
1 year ago
Hmm, the default probabilities and the joint default probability are given, so I should be able to work this out. Let me think it through step-by-step.
VA
Vallie
1 year ago
This looks like a tricky one. I'll need to brush up on my probability and correlation calculations to tackle this.
EU
Eura
1 year ago
D) 25%
KE
Kerry
1 year ago
C) 40%
RU
Ruthann
1 year ago
B) 100%
AB
Abel
1 year ago
A) 0%
KA
Kanisha
2 years ago
But if the probability of default of the two bonds are 0.03 and 0.08, then the default correlation should be 40% according to the formula.
SO
Sommer
2 years ago
I disagree, I believe the default correlation is 25%.
KA
Kanisha
2 years ago
I think the default correlation between the two bonds is 40%.