Fixed Income and Credit Risk Professor Michael Rockinger

Faculté des Hautes Etudes Commerciales de

l’Université de Lausanne

Fixed Income and Credit Risk, Prof. Rockinger

Session ETE 2023

4 hour online exam

You have the right to consult your lecture notes and books (either printed or on
your computer as PDFs). You should do the computations on your computer with a
Software such as Excel.
You do not have the right, however, to consult your classmates to help you obtain
the answers to the questions asked below. Nor are you allowed to access the
internet, besides the Moodle platform.

Each question has one answer. One point will be removed per wrong or
unanswered question.

Name and First name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

This examination has 23 questions, for a combined amount of 50 points.

Fixed Income and Credit Risk 22 Juin 2023

1. (2 points) : On your computer screen, your data provider gives you the following informa-
find 1) z first
tion:
from Eliott :

210 5) + 100
+o 20 ,

E
210, 0
99 , 0728
.

50, 0006
.
3
13050210 0 3)
+ 50
+30 (2,
Bond Number Price Coupon rate Facial Maturity
=
, .

1 99.0728 2.20% 100 1 year 2) find r 10 , T) using z

2 50.0006 3.15% 50 1 year

The price is the invoice price. The coupon payments are semi-annual and take place the same
day. The last coupon payment was made a couple of minutes ago. There are 6 months till the
next payment date. The 2 compounded rates corresponding to the term structure, i.e. the 6
months and 12 months spot rates, are up to rounding:
One writes the system of equations:
" # " # " #
P1 C1,1 C1,2 Z(0, 6M )
= ⇥
P2 C2,1 C2,2 Z(0, 12M )

decimals.
S
The rest is resolution for the discount factors Z(0, 6M ) and Z(0, 12M ) and inversion to get
the rates. To get the solution, it is particularly important to work with the full set of available
④ [11 2 2 % 0 =
1
, ② do adjacent and compute det
= 1
,

d
a : (2.64%, 3.01%) 212 1 1 100 101 I +

[
= =

&
,
222 ,

b : (3.21%, 2.98%) ( 3 15
50 = F
= , 787 % det Gaz = 0
.
= -

Co
-
c : (2.98%, 3.15%) 7875 50 7875 + 50
= - 23 73
,

222 0, =
= ,

d : none of those answers

③ inverse (ij ③ 210, 0 .
5) = Alza ·
P1 + 1-A(12) oPz = 0
.
99
-
① re10, 0 5) =
2
#;
A
.

2(0, 1) Adz opu ACuoP2 210, 0 3) 1

-
= -

+ 0. 97
.

=
def 0, 03
AC11 = - 0
, 03 = 2, 98 %
-

A(2) =

2. (1 point) : On your data provider’s display you find the following discount factors corre- r2(0 1) = 2
-
1

2(0, 1)
.

, -
1

sponding to the current spot term structure: = 3 , 15 %

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

What is the annualized coupon rate for a plain vanilla par-bond which pays every 6 months a
constant coupon and has as maturity 2 years from now?
a: 2.77% =
( -

2(0 ,TM)
c

b : 2.83% E210 ,Til

c: 2.91%
.(109453)
= 2 = 0 02832 -.
d: none of those answers - ,

3. (1 point) : On your data provider’s display you find the following discount factors corre-
sponding to the current spot term structure:

Page 2 sur 15
Fixed Income and Credit Risk 22 Juin 2023

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

You are the chief structurer of your bank and a client just called requesting a quote to lend
forward for 1 year in 6 months. You provide which annualized 2-compounded forward rate?
M)
a: 2.2588% #10 6 M 18M) , ,
=

210, 6M)
-

1937 = 0
,
971881 - 97, 1881 %

b : 2.8726%
(FM, 1)
+ 10 6M 18M) .
= =

. 2 =
0 028726 + 2, 8726 % V
, ,
M
c: 2.9946%
d: none of those answers

4. (3 points) : On your data provider’s display you find the following discount factors corre-
sponding to the current spot term structure:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

In the following all rates are 2-compounded rates quoted as usually on an annualized basis.
Swiss Credit (SC), a bank, quotes a 6 months forward rate starting in a year at 2.59%. An
other bank, Swiss Associated Bank (SAB) quotes for the same time period a rate at 2.42%.
Once those rates are quoted, banks must borrow and lend at those rates for amounts up to 100
mio notional. You decide to arbitrage this situation using a notional amount of not more than
100 mio. Your goal is to maximize the gains. You are asked to fill in the missing terms. You
should ______
borrow from SAB bank and ______
lend SC . Your gain will be approximatively: ______
to

3 since rate is lower

& G SAB is forced to borrow at high rate

You have the forward rates for the banks. Just need to compute the forward rate for a synthetic
forward position. For the latter, you just determine what the forward rate should be given
the discount factors. F(0 12 M 18M) ,
98
,
=
= 0
,

f2 (0, 12M, 18M ) = 2.53% =

2875 -

1) (1)
f2SC (0, 12M, 18M ) = 2.59% (2)
f2SAB (0, 12M, 18M ) = 2.42% (3)

Both banks quote forward prices that can be arbitraged. The differential of rates is maximal
if one borrows at the low SAB rate and lends to the high SC rate. The gain is found to be
E
85k.
No (fzSC-feSAB) 50 (2 59 % 42 ) 2 % 85000
a : borrow from / lend to SC/ 85’000 100 mio · = - 0 ,
-

,
=
.

b : lend to / borrow from SC / 92’809

c : none of this. You should borrow from SAB / invest in a synthetic forward in the market
/ 399’077
d : none of those answers

Page 3 sur 15
Fixed Income and Credit Risk 22 Juin 2023

5. (3 points) : 37 days ago, the term structure of discount factors was as indicated in the
following table.

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

In the meantime, this term structure has changed into:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9846 0.9690 0.9582 0.9455

37 days ago, Scitech, a well established firm producing high-tech loudspeakers, entered into a
non-skewed 6 months FRA reset in 12 months, receiving variable and paying fixed (both rates
are semi-annual compounding) for a notional amount of 100. We assume a year has 360 days.
The current value of this FRA is: T
3 10278 = = = 0.

Since the FRA got issued non-skewed, we know from lectures that the FRA rate is the forward
rate. Get f (0, 12M, 18M ) = 2.5277%. The payoff at 18M is:

N (r2 (12M, 18M ) f (0, 12M, 18M )).

Using the no-arbitrage argument, today’s value is:

N (Z 0 (t, Ti 1) Z 0 (t, Ti )) N f (0, 12M, 18M )Z 0 (t, Ti ).

Where Z 0 corresponds to the discount factors running from day 37 to the original 12M, and

3
z
0, 9878 use

18M dates. 2 (T Ti)

,
210 Ti 1)
=
* 210 ti) E
, -
·
D-T
+ #(0
,
18 M)· 98 73 F(t ,
12
,
=
, % ,
12 m
,
18M) =

of interpolets
f2 10 M 18M) 53 filt 12 2 %
12M 18 M) = 0, 0243

a : 3.493
, , = , ,
seeexcel solutions ,

b : 1.882 value (t 12 M 18M) 2 It 18M) N 0 (fz(t 12 m 18M)

felO 12 M 18M)) 035 - 0
= = -
· · ·
,
, , , , , -

, ,

c : -0.035 > Notist 12M) 18 M) -210 12 m 18M 0 2 10 18 M)) 033)

2110 0

C
-
.
=
·
,
-

excel -
-

, , , , ,
ou
w
d : none of those answers 6 reset
dates at

12M

6. (3 points) : The term structure of interest rates is given by the following discount factors:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

A plain vanilla bond pays quarterly coupons and, of course, the facial amount at the maturity
date. The next coupon is in 29 days (a year has 360 days). There remain 8 coupon payments.
The facial amount is 25 and the coupon rate is 3.27%. Determine the clean price (expressed
in terms of percent of the facial value). T 0 and need to interpolate for quartly moments
= 2 (0
, ,
0
.
25)
by doing average . Then compute 21t T) using
,
other formula of
First, one needs to interpolate the discount factors to get quarterly discount factors. This interpolation

corresponds to a payment every 90 days. Then take into account the 90-29=61 days elapsed.

Page 4 sur 15
Fixed Income and Credit Risk 22 Juin 2023

Use the same formula as above. Clean price=Dirty minus accrued interest. ↑

a : 99.55% [F F 21t Ti) . .

clean price price

= ,
·

b : 100.76% - -
*n=
1

=C
-

I -

accured interest
c : 101.22% ·

accrued interest
d : none of those answers clean price price
·
= -

price
can
· ratio =

7. (2 points) : The term structure of interest rates is determined by the following discount
factors.

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

A bond pays semi-annually an annualized 4.17% coupon rate for a facial of 100. The last
coupon was paid a couple of hours ago and the bond has a residual life of 2 years. Currently,
if you buy this bond, you would have to pay an invoice price of 112.47. The 2-compounded
yield to maturity of this bond is:
Solution is pretty trivial. Use goal seeker in Excel or try as solutions the given rates.
a : -1.92% T données >
-
analyso scenarto -
valeur cible

b : 0.33% cellule à definit

·

celle difference prix

=

c : 3.52%
valeur à atteindre
·
= 0
d : none of those answers ·
cellule à modifier =
de yield
celle

8. (2 points) : Your friendly data provider’s application displays on one of your numerous
screens the following discount factors:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

A company will receive two fixed cash flows of 5 mio in 18 and 24 months from today. On
the other hand, the firm has variable commitments that are related to some variable reference
rate. This reference rate is reset after 12 months and after 18 months. For this reason, the
firm wishes to enter into an interest rate swap which will convert the fixed payments into some
variable ones. The tenor would be 6 months and the cash flow exchanges would take place

&
contemporaneously with the fixed cash flows of the firm. Indicate if you want a payer or a
receiver swap. Determine the swap rate that the firm will get if the swap is not skewed as it
is market practice. tenor length
= duration of swap
or

Given that the reset date is not immediate, it results that the company wishes to enter into a
forward starting payer swap. It’s a payer swap since the firm will transfer the fixed payments
she receives to the bank who will pay variable.

Page 5 sur 15
Fixed Income and Credit Risk 22 Juin 2023
2(0 , 0)
↓
a : payer swap, 2.52% -210 2913-
Tm) ,
swap rate = _

b: receiver swap, -1.77% [(210 , Til(

c: payer swap, 3.12% 210, 12 m) -

210 , 18M))
2 52 %
=
-
=

d: none of those answers

,

210, 18M) + 210, 24M)

>
- 6 reset date in 12M & I8M so we take 6 months tenor
from reser date !
9. (3 points) : You get the following information on your data display:
r10, 0 3) ·0. 5
find 5) 9795
.

2(0
-

can 0 = e 0.
> =
.

- ,

• The 6-month spot continuous compounded rate is 4.15% fr 1 ?, GM 12 M)

FRA receiver & ,

↑
• A FRA, issued in the past, receives a fixed semi-annual rate of 4.27% in 1 year from now.
At that time it pays a 6-month floating rate, for a notional amount of 10 mio. Currently
No
this contract has a value of 120’000. T =
z
>
- Ut
• A swap maturing in 18 months with tenor 6 months pays a semi-annual fixed rate of
3.85%. The last reset was a couple of minutes ago. -
> so we are at 12M
c

The price of a zero coupon bond paying 100 in 18 months is up to rounding?

ve/N using Ut formula
0 97077
210 0 3) +
210 1)
.

= , -
=
, - -
.

To fl ?, CM , 12 M) +1

• We have the continuous compounded rate r(0, 0.5) so get immediately Z(0, 0.5) = e r(0,0.5)⇤0.5 .
rate
using coupon
• The payoff of the FRA is * c
formula =
% 5
,
. c .
(210 ,
0 . 5) + 2(0, 1)) = 0
. 9443
210, 1 5) . =
1 + 0 5 %
C
.

N (f (?, 6M, 1Y ) r2 (6M, 1Y )] 94, 13

Price = F
o 210, 1 .
5) =

where f (?, 6M, 1Y ) is some notation to indicate that the FRA was written at some
unknown date in the past. It does not matter when since we are given the value of the
contract and we try to determine the discount factors. Discounting the symbols, get

Vt = N f (?, 6M, 1Y )Z(0, 12M ) N [Z(0, 6M ) Z(0, 12M )]

With some algebra find that

Z(0, 1Y r) = [Vt /N + Z(0, 6M )]/[1 + f (?, 6M, 1Y )].

• The swap rate is given by the formula:

1 Z(0, 1.5)

a
c= .
[Z(0, 0.5) + Z(0, 1) + Z(0, 1.5)]
From there extract the Z(0, 1.5). Get:
1 c(z(0, 6M ) + Z(0, 12M ))
Z(0, 1.5) =
1+ c
a: 93.69 C (210, 6 M) + 210, 12 M) + 210, 18M
1 (210, 18M) 1 -

b: 93.73
c : 94.43
2 0, 18 M) + 0210 18M) ,
= 1 -

-C(210 6 M) + ,
210, 12 M)
d: none of those answers 210,18M) (1 + (c)
· = 1 -

02(210 6M) ,
+ 210, 12 M/

(2(0 6M) + 2(0 12M)

210 , 18 M) = = , ,

1+ C

Page 6 sur 15
 Fixed Income and Credit Risk 22 Juin 2023

10. (1 point) : The market-to-market ledger of a clearing house has values at 6 and 5 days
before maturity as indicated in the table below. The Futures price is related to the spot rate
via Ft,T = St (1 + r)T t . In the ledger, time is given in days before maturity and there are
360 days in a year. The term structure is supposed to be flat and constant over time at an
annualized rate of 4.5%.

T t Margin Maintenance Futures Spot Maintenance Margin

Account Margin Price Price Margin Account
Short Short Ft,T St Long Long
① 6/360 0.4 73.79 73 , 74 0.42
② 5/360 74.12 74 . 07

The rules of the clearing-house are as follows: If the amount in a margin account falls below
0.5% of the futures price then the margin account needs to be filled to 2% of the ongoing
4758
futures price. 2% Fo
& 2% 073 79
0
T
>
-
,
= 1,

② 2%. 74 , 12 1 , 4824
Between days 6 and 5 before maturity, the following will happen.
=

This is best done directly in Excel. Answer a is correct. One can also compute the change in
spot price (asked in c) but this does not match.
a : Short gets a margin call for an amount 1.4124
spot price
+- =
b : Long gets a margin call for an amount 1.3762
mainte
Margin - 06/360 : Fo . 3% 3690
,
1.
0. = 0,

② 31360
c : The spot price changes by 0.42 false by 34 >
- ,
0
.
Fo 5% 3706 !
:
,
20 0. = 0.

d : none of those answers maint

Margin Short
> ⑪ : 0 4
- .
and margin
,
Short & -

(Fo 2 - Fo 1)
, ,

= 0, 4 -

(74, 12 -

73, 19) = 0 07 !
1 , 4124
.

margin call 1, 4824-0. 07 0

(Fo
= =
long marg +
d
0 42 @ Fo 1)
.

: 0 2
margin long
:
-

>
- , ,
,
below
= 0 42
, + (74 ,
12 -
73, 19) = . 75
0
maintenene
11. (2 points) : The market-to-market ledger of a clearing house has values at 6 and 5 days margin of
0 , 3706 !
before maturity as indicated in the table below. The Futures price is related to the spot rate
via Ft,T = St (1 + r)T t . In the ledger, time is given in days before maturity and there are
360 days in a year. The term structure is supposed to be flat and constant over time at an
annualized rate of 4.5%.

T t Margin Maintenance Futures Spot Maintenance Margin

Account Margin Price Price Margin Account
Short Short Ft,T St Long Long
6/360 73.79
5/360 75.99

The rules of the clearing-house are as follows: If the amount in a margin account falls below
0.5% of the futures price, then the margin account needs to be filled to 2% of the ongoing
futures price.
In the following we neglect any interest that would be paid on a margin account.

Page 7 sur 15
Fixed Income and Credit Risk 22 Juin 2023
smaller the Fo,T1 = 73, 79)
&
It turns out that at 6 days before maturity, the spot price takes a value of 73.20. The quoted
prices hold for a lot of 1000 units. At day 5 before maturity, the market spot price is equal to
the one implicit in the futures price. Buy in spot for 73 20 and sell forward at 73 79 , ,

Which of the following statements is true: gain = 0, 59

At 6 days before maturity the spot price is too low in contrast to what the futures market
implies. One should buy what is cheap, that is buy the asset in the spot market for 73.20.
One finances this by a credit of 73.20. At the same time one sells the asset forward. This
costs nothing by definition of a-> 73 20 11 043)1360 -73 21
futures. -

repay credit
,
·
, = ,

At day 5 before maturity, the spot price is at its fair value. I sell the asset for 75.94. I take
an offsetting position in the futures, i.e. a long position. This costs nothing by definition of
a futures. I lost 2.2075due to the margin variation. I need to reimburse the banker 73.20(1 +
73 79 3
,
99 -
.

r) 1/360 = 73.21. Total gain for one unit of underlying is 0.535, I do this 1000 times leading to
a gain of 535..
a : Take a long position in the asset, place in a bank account and collect the margin variation
b : Among others, by taking a short position in the futures, for 1000 units one can realize a
gain of approximately 535
c : Among others, by taking a long position in the futures, for 1000 units one can realize a
&
gain of approximately 270
d : none of those answers

12. (2 points) : The following table indicates the current annualized 6-month spot rate and
various 2-compounded annualized swap rates.

r2 (0, 0.5) c2 (0, 1) c2 (0, 1.5)

3.99% 4.15% 4.35%

The 18 months annualized 2-compounded spot rate compatible with those rates is:
⇣ ⌘ 2⇤0.5
We have Z(0, 0.5) = 1 + r2 (0,0.5)
2 almost directly from the screen. Denote the swap
rates for times T by cT then recursive inversion of the formula of the IRS swap rates gives:

1
. 9804
1 2 c1 Z(0, 0.5)
2(0, 0 . 3) = 0
Z(0, 1) = = 0 . 9597

1 + 12 c1

1
1 2 c1.5 [Z(0, 0.5) + Z(0, 1)] = 09374
Z(0, 1.5) = .
1 + 12 c1.5
To go from Z(0, 1.5) to r2 (0, 1.5) is pure routine.
a : 4.36% m
b : 4.59%
r10 ,
1 .
5) = no (210 ,
1 . 3) -
1)
s
=
20 10 9375-. -

1) =
4 , 36 %

Page 8 sur 15
Fixed Income and Credit Risk 22 Juin 2023

c : 4.64%
d : none of those answers

13. (2 points) : On your data provider’s display, you find the following discount factors
0 5 1, 5
12
.

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

A bond was issued some time ago. Its coupon rate is 3.55% and it pays semi-annually. Its
nominal amount is 100 and it has a residual maturity of 18 months from today. It just paid
a coupon. You want to enter into a forward contract where the underlying is this bond. The
maturity date of this contract is right after the next coupon payment which is expected to
take place in 6 months. The forward price is:
To price this forward contract, one uses two strategies, both aiming to obtain the same cash
flows of the bond. One strategy involves the forward contract, the other one involves the bond
in the duplicating strategy.
Strategy 1: Write a long forward contract where you commit to pay F in 6 months to get
delivery of the bond after the coupon has been paid. The value today of this strategy is
F · Z(0, 0.5).
Strategy 2: Buy the bond now, but take a credit corresponding to the coupon payment. This
credit can be reimbursed with the coupon. The value of the bond is (to avoid confusion,
coupon =Fe
10
denote by N the facial=nominal amount. 2

✓ ◆
cN cN cN 1 775 > from
-
to
=

,
P = Z(0, 0.5) + Z(0, 1) + + N Z(0, 1.5) s
,

2 2 2 to ty
coupon = 101 , 775
The discounted value of the coupon is: +, g
+ F =

cN
Z(0, 0.5) P = [210, Ti) ·

Coupon :
2 +

And combining everything get:

✓ ◆
cN Z(0, 1) cN Z(0, 1.5)
F = + +N
2 Z(0, 0.5) 2 Z(0, 0.5)

a: 99.33
b : 100.66
c: 101.88
d: none of those answers

14. (3 points) : The current term structure of risk-free discount factors is given by the following
table:

Page 9 sur 15
Fixed Income and Credit Risk 22 Juin 2023

time Ti 0.5 1 1.5 2

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

A plain vanilla coupon bond pays at the dates for which the discount factors are given. The
annualized coupon rate is 3.56%. This bond is issued by a corporation and is therefore prone
to default risk. For this reason, this bond is discounted with a term structure of interest
rates 32bp higher than the regular continuous compounded risk-free structure. Duration and
convexity are expressed in years and years squared. The duration and convexity of this bond
are given by the following pair of values: 1) need to recompute 210 ti) with , default risk

Straightforward computations. Ti) r 10 , Ti) en

((
= -

Wi =
P
a : (1.95, 3.85)
r' (0 Ti) r10 ,Ti) 0 . 32 %
b : (1.95, 4.10) 1 95 , = ·

D Evi Ti
=
,
= ·

↑ spread of 32 69
c : (2.10, 4.10)
- r'(0,Ti) Ti
o

EvioTi2 3 85 z'(0 Ti) = e

convexity = = ,
,

d : none of those answers 2) F Duration & don't depend

assume = 100 since
convexity
and compute wi ,
D and C

Price = [c .
F . 2(0 Ti)
,
= 100 ,
79

15. (3 points) : The Swiss Credit bank has the following asset-liability structure. S.t, M.t, and
L.t correspond to short, medium and long term. From you accounting classes you remember
that on the balance sheet, there also figures equity: total debt plus equity must equal assets.

Assets (mio CHF) Duration Liabilities (mio CHF) Duration

cash 300 0 Deposits 2000 0
S.t. loans 1000 0.8 S.t. debt 1300 0.5
M.t. loans 1700 3.5 M.t debt 1100 3.5
L.t. loans 3345 10 L.t. debt 1600 9

The management team of this bank got just replaced. As new chief risk officer, you are asked
by your boss to run a risk management exercise where it is assumed that the level of interest
rates increases suddenly by 5%? The theoretical change in the value of equity after this shock
is how much approximately?
This was a duplication of Exercises 5. Different numbers, identical music. equity A =
- L = 345

a : -1065
tot asset tot
R = tot
DA-tot liabilities
o
Dy 21300 =

b : -1230
c : -1340 Ro 5 % 21300 5 =
1065 need to put
·
%
negative
= -
sign be Duration = -
D Dr
o

d : none of those answers

than liabilities creating
assets have higher duration will drop by more
if interest rates go up ,

a
gap that needs
to be filled by equity

16. (3 points) : The current term structure is defined by the following discount factors

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

Page 10 sur 15
 Fixed Income and Credit Risk 22 Juin 2023

You have to generate by time 14 months from now an amount of 20 mio. To do so, you will
create a portfolio of a 12 months to maturity bond and an 18 months to maturity bond. Both
bonds are issued today at a par value of 100, both pay semi-annual coupons. Indicate the
number N1 of short-term and the number N2 of long term bonds that immunize against small
interest-rate fluctuations. Indicated the numbers N1 and N2 that you find up to rounding.
We need to find the discount factor for 14M. This is done by usual interpolation. Then we
obtain the discounted value of the 20M. We find the coupon rates for the two bonds which is
easy. For the following we remember that since both bonds are placed at par, P1 =P2 = 100.
Then determine the durations of each of the bonds.
& N 210 1PM) 20 mio 9655 .

,
= . 0
.

Finally, set 19 309333 mis =

,

14
D= = a ⇥ D1 + (1 a) ⇥ D2 210 , 14M) >
- interpolate
12
D D2 = 4 -
2(0, 12M) + 2 . 210 , 18M)
)a=
D1 D2 6

N1 P1 aP n (1 -

2(0, 12M))
a= ) N1 =
=

m =
0 0312
- ,

P P1 210, 6M) + 210, 12M)

N2 P2 (1 a)P
1 a= ) N2 = . (2 =
-2101 M1)
1 0293
P P2 210, 18 MI
= 0
,

2(0 , 6 M) + 2(0, 12 M) +

D = 0, 9923
>
-
a : (123’847, 69’246) ② = = 1 , 167 for each bond compute Duration
-
>
D2 =
1 , 478
b: (129’989, 61’159)
c: (128’729, 64’364)
a

=
d: none of those answers N 210 14M)
18M) 14
.
,

③ N 210 , Nz 69246
o

N1
. = =
=
= 123847
Pr P2

⑧
17. (2 points) : Some asset has as dynamic
p
drt = (✓ rt )dt + rt dWt ,

where dWt is an increment of a Brownian motion. t denotes a time index. For some model
1/2
that you developed you have to obtain the dynamic of xt = t rt . Which expression do you
obtain for the stochastic differential equation of xt ?
We seek

1 2 @2f @f @f p @f
dxt = df (rt , t) = rt + (✓ rt ) + dt + rt dWt .
2 @rt2 @rt @t @rt
Since
@f ( +1) 1/2
= ( )t rt
@t
@f 1 1/2 revoir les
= t ) rt
@rt 2 formu
@2f 1 3/2
= t ) rt
@rt2 4

Page 11 sur 15
Fixed Income and Credit Risk 22 Juin 2023

Replace above and get:


1 2 1/2 1 1/2 ( +1) 1/2 1
dxt = t rt + (✓ rt )t rt t rt dt + t dWt .
8 2 2
a:

1 2 1/2 1 1/2 ( +1)/2 1/2 1 1/2
dxt = t rt + (✓ rt )t rt + t rt dt + t rt dWt .
8 2 2

b:

1 2 1/2 1 1 1/2 ( +1) 1/2 1 1/2
dxt = t rt + (✓ rt )t rt t rt dt + t rt dWt .
8 2 2

c :

1 2 1/2 1 1/2 ( +1) 1/2 1
dxt = t rt + (✓ rt )t rt t rt dt + t dWt .
8 2 2

d : none of those answers

18. (2 points) : Our data provider feeds into our computer the latest information about the
discount factors as displayed in this table

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

Your task is to price a CDS with the following specifications. The company that issues the CDS
is AXA, a large French insurance company. Given that the CDS will be heavily collateralized,
we can neglect the counterpart default risk of the insurer. Future cash flows can therefore be
discounted with the risk-free rates given by the term structure in the table above. The firm
on which the CDS is written belongs to a class of assets where the default intensity has been
estimated to be 4%. You may assume that the default arrivals are driven by a homogeneous
Poisson process. The insurance buyer needs to pay an amount A every 6 months, starting in
6 months, until a default takes place. Then, there is no more payment. The issuer will pay
500’000 Euro in case of default at the first payment time after default. The CDS matures
after two years.
You want to ensure that the amount AXA asks you to pay, A, is correct. Which value should
AXA propose to you ?
Denote by ⌧ the time of default. We have
PN 074169845
Z(0, Ti )P r[Ti 1 < ⌧ < Ti ] -,

A = L · i=1 PN = Le

i=1 Z(0, Ti )P r[⌧ > Ti ]

3, 671530944

Page 12 sur 15
 Fixed Income and Credit Risk 22 Juin 2023

Furthermore for a Poisson Process we have exponential waiting times between events and thus
P r[⌧ > T ] = e T and P r[Ti 1  ⌧ < Ti ] = e Ti 1 e Ti .
a : 10’096 N
500 000
X 4% = =

b : 10’101
numerator
10101
c : 10’121 L No =

denominator
-
=

d : none of those answers

O
19. (2 points) : Your preferred data provider feeds to your Excel spreadsheet the following
discount factors:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

Dring, drinG! Your phone is ringing. Stress!! One of your most important clients wants to
buy a FLOOR right NOW! The required characteristics of the FLOOR are as follows. The
notional amount is 1’500’000. The flat volatility is given by 12%. The underlying reference
rate is a 2-compounded spot rate. This reference rate corresponds to the rates generating
the term structure defined by the discount factors above. The FLOOR consists of 3 floorlets as
one
or same
paying in 12, 18, and 24 months. The reset dates are always 6 months before the payment in résume
~

-
dates. Which value do you find for the FLOOR given that the strike rate is 2.89%?
a:
b:
5801.81
5780.78
1) compute F10, Ti , Til

ti)
= and
f2(0 Tire Til
an
,
,
=

no -1)
Eflooret 2) dn en ( + 0
. 500 t
k)
: 5753.49=
Black & Scholes (En10 Tie Til
=
2(0,Ti)
c N
-

5) caplet
·

>
-
· ·
-
, ,

Fin
-t formula = Floorlet
d: none of those answers
.

d
3)
d2 = en Atti) ( -
0
. 50
do Plan) and $(dz)

↑ Caplet = N 4, 210,Ti) ·
(fn10 Ti
, -1 , Ti) $(11)
·

:
- KoP(dz)) !

. Fin
-E
20. (2 points) : As Chief Risk Officer, you studied the accounting data and company charac-
teristics of the firms to which you lent money. After regrouping the assets by risk, a historical
database containing default information has the following properties: in a given risk category
there are 200 firms and among those firms 2.5% of the firms defaulted in a given year. Now is
time t = 0, what is the probability that a firm in this risk category will default between times
0.5 and times 0.75? You may assume that a Poisson model fits this data well.
We have, if ⌧ denotes the time of default of a firm, that

0.5 0.75
P r[⌧ > 0.5 months and ⌧ < 0.75] = (e e ).

Since we are told that a Poisson distribution suits this data well, we can use the property that
the parameter is the expected value of the Poisson counter. Since the Poisson counter counts
the number of defaults, we convert the percentage of firms in an actual number of defaults.
This makes 5 firms that defaulted (2.5% in 200). So = 5. Excel does the rest.

Page 13 sur 15
 Fixed Income and Credit Risk 22 Juin 2023

a: 4.098%
b : 5.857%
c: 8.015%
d: none of those answers

⑧
21. (2 points) : Your preferred data provider feeds to your Excel spreadsheet the following
discount factors:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

Your boss asks you to obtain the implied volatility of a floorlet with the following parameters:
the notional amount is N = 100 000 and the strike rate is k = 3.9%. The floorlet has as
underlying asset a 6M reference rate r2 (Ti 1 , Ti ) with reset date 6M and payment date 12M.
The option gets exercised at 6M. The price of the floorlet is 33.056. Which annual percentage
volatility do you obtain after rounding to the unit?
The FLOORLET formula is in the slides. Implementation in Excel yields a volatility of 8.9%.
a : 6% d
b : 7% using goal seeker to find o
c : 9% with Floorlet 33 036 using course formula = ,
>
-

d : none of those answers and the given price 33 056 =

,

Thus difference = floorlet-

given price = 0

O
22. (2 points) : Your preferred data provider feeds to your Excel spreadsheet the following
discount factors:

time Ti 6 months 12 months 18 months 24 months

Z(0, Ti ) 0.9851 0.9695 0.9574 0.9455

Your boss asks you to determine the value of a payer swaption, whose underlying IRS pays at
the dates 1, 1.5 and 2, with strike rate k equal to the value of the forward starting swap rate
plus 10 bp. The forward starting swap volatility is 12%, the notional amount is 5 mio and
the swaption matures at T0 = 6 months. Given your excellent training in a certain Master’s
program, after hitting your keyboard you find that the price of this swaption is up to rounding:
a : 3824 !
revoir ,au -

b : 3854 C

c : 3924
formules payer sception NO Annuity (fS10 To Tm) P(de) K Pldz) 3824 = :

, ,
· -
. =

d : none of those answers To To Receiver swaption payer swaption = N U annuity

,
3
(fs (0 To +m) () 11004 = - .
.
·
, ,
- =
,
74

f5(0 , To , Tm) = 0, To
,
Tm)
= 2 , 76 %
0 5
.
.
EF10 To Ti)
,
,

k = 1510 To Tm)
, ,
+ 0
.
1% = 2 86 %
,

value annuity = 210

,
T1) + 210, +2 ,3) + 210, T2) = 2, 8724

Page 14 sur 15
Fixed Income and Credit Risk 22 Juin 2023

23. (2 points) : After studying the temporal evolution of defaults in a certain industry you
have come to conclude that a) there is lots of fluctuation in the default intensities over time,
b) that the Poisson model applies well to your data and c) that you have a pretty good model
to actually forecast the future default intensities. The following table summarizes the default
intensities for various time intervals.

number of interval i 1 2 3 4
time interval 0-6 months 6-12 months 12-18 months 18-24 months
2.5% 3.0% 3.5% 4.5%

You wish to determine the probabilities that a default occurs between the end of the 14th
month and the end of the 15th month from now and the probability that there is no default
in the next 2 years. What is the pair of values that you obtain?
One has Z T
P r[⌧ > T ] = exp( u du)
0
The are piecewise constant. So we obtain for T1 = 14/12 and T2 = 15/12:
&
14M
-15M
P r[T1 < ⌧ < T2 ] = exp( ( 1 + 2 ) ⇥ 0.5 3 ⇤ (T1 1)) exp( ( 1 + 2 ) ⇥ 0.5 3 ⇤ (T2 1)) = 0 28 %
,
- -
Pr(t> /4M)
The probability of no default before 2 years is -
e 0.5( 1 + 2 + 3 + 4 ) Pr(Es15M)
a : 0.22%, 96.03% Pr(Es18M) 93 =
,
47 %

b : 0.35%, 93.47%
c : 0.28%, 93.47%
d : none of those answers

Page 15 sur 15