Question $1$

$[10]$

a$.$ Explain the two most important drivers of credit risk and how those relate to the probability of default $($PD$).$

b$.$ As head of credit risk at Daspoort Investment Bank, you are considering approval of a five$-$year credit asset $($business term loan$)$ with a bullet $($balloon$)$ repayment at the end of a term. The term loan shows a marginal probability of defaut of $1\mathrm{.}3\%,1\mathrm{.}5\%,1\mathrm{.}2\%,1\mathrm{.}7\%,$ and $2\mathrm{.}2\%$ for each of the five years, respectively. How would you find the cumulative probability of default over the five$-$year period for pricing purposes?

Question $2$

$[10]$

The Merton model, which was proposed in $1974$ by economist Robert C$.$ Merton, is a mathematical formula that stock analysts and commercial loan officers, among others. can use to judge a corporation's risk of credit default and ability to retain solvency. This model assesses the structural credit risk of a company by modeling its equity as a call option on its assets.

With the above statement in mind, the current value of the assets of Sibasa Agricultural Holdings is R$130$ million. The assets are financed by a mix of equity and zero$-$coupon debt. The current value of the zero$-$coupon debt is R$75$ milion, and the final amount to be paid on maturity after five years is R$120$ million, with an effective interest rate of

$2025$ RSK$4804$ Assignment $1$

$13\mathrm{.}25\%.$ The volatility in Sibasa Agricultural Holdings' asset value is $23\%.$ The following is required:

a$.$ Compute the probability of detaull $($PD$)$ of Sibasa Agricultural Hoidings based on the Merton model.

b$.$ What is the impact on probability of default $($PD$)$ if the volatility suddenly decreases to $21\%?$