Explanation:
Portfolio Characteristics:
$1,500,000Impact of Default Correlation: Because the default correlation is 1, all bonds will default together or survive together. The portfolio acts like a single bond with a default probability of 2%.
Expected Loss:
Expected Loss = Portfolio Value × Default Probability = $1,500,000 × 0.02 = $30,000.
Credit VaR at the 95% Confidence Level:
At a 95% confidence level, we look at the 95th percentile of the loss distribution. Since the default probability is 2%, the worst 2% of cases result in a $1,500,000 loss, while the remaining 98% of cases result in a $0 loss. The 95th percentile falls within the 98% of cases where no default occurs.
Loss at 95% confidence = $0.
Credit VaR = Unexpected Loss = Loss at 95% - Expected Loss = $0 - $30,000 = -$30,000.
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Q.5539 A financial portfolio has a total value of $1,500,000 and consists of 15 equally valued corporate bonds. Each bond has a default probability of 2% and a recovery rate of zero. Since all bonds are issued by the same corporation, the default correlation between them is 1. What is the Credit Value at Risk (VaR) at the 95% confidence level for this portfolio?
A
$1,500,000
B
$0
C
$30,000
D
-$30,000
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