Answer: 16.5%

Since the bond defaults are independent and identically distributed Bernoulli random variables, the Binomial distribution can be used to calculate the probability of exactly two bonds defaulting. The correct formula to use is: \[ P(K = k) = \frac{n!}{k!(n-k)!} \cdot p^k (1-p)^{n-k} \] where \( n \) is the number of bonds in the portfolio, \( p \) is the probability of default of each individual bond, and \( K \) is the number of bond defaults over the next year. Thus, this question requires \( P(K=2) \) with \( n = 5 \) and \( p = 0.17 \). Entering the variables into the equation, this simplifies to \( 10 \times 0.17^2 \times 0.83^3 = 0.1652 \).

Author: LeetQuiz Editorial Team