(a) Define the term credit risk and describe the key inputs required in models of credit risk....
Question:
(a) Define the term ‘credit risk’ and describe the key inputs required in models of credit risk.
(b) Suppose that you are working for a bank that has lent €5 million Euro to firm YZ. Your manager is concerned about its ability to meet its repayments. Advise your manager as to how you can hedge this credit risk? Provide a numerical example.
(c) An American call option on a non-dividend-paying stock, with a strike price of $100 and an expiry date in six months, currently sells for $5. The underlying asset currently trades for $95 per share and the risk-free rate of interest is 10%. What are the upper and lower price bounds for an American put option written on the same stock, with the same strike price and the same time to maturity? Why is it not possible to derive a parity condition for American options on non-dividend paying stocks?
Expert Answer:
aCredit risk is the risk of losses stemming from a borrowers inability to make debt repayments Key inputs in models of credit risk include exposure at default loss given default probability of default ... View the full answer
