Financial Risk Manager Part 1
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A fixed-income portfolio manager holds a diverse assortment of bonds issued by various companies. Given that each bond in the portfolio has the same annualized probability of default and that the defaults of these bonds are independent events, what type of probability distribution would best describe the number of bond defaults that the manager can expect in this portfolio over the next year?
A fixed-income portfolio manager holds a diverse assortment of bonds issued by various companies. Given that each bond in the portfolio has the same annualized probability of default and that the defaults of these bonds are independent events, what type of probability distribution would best describe the number of bond defaults that the manager can expect in this portfolio over the next year?
Explanation:
The correct answer is C, Binomial distribution. This is because the situation described involves a fixed number of independent trials, where each trial (in this case, each bond) has the same probability of default. The binomial distribution is used to model the number of successes (defaults, in this context) in a fixed number of independent Bernoulli trials, each with the same probability of success (default). The explanation clarifies that while a Bernoulli distribution describes the likelihood of default for a single bond, the binomial distribution is appropriate for the entire portfolio, as it encompasses a group of Bernoulli distributed variables.