The correct answer is: C).

In general, if there are n ordered observations, and a confidence level cl%, the cl% VaR is given by the \([(1 – cl \%) n + 1]th\) highest observation. This is the observation that separates the tail from the body of the distribution. For instance, if we have 1,000 observations and a confidence level of 95%, the 95% VaR is given by the (1 – 0.95)1,000 + 1 = 51st observation. There are 50 observations in the tail.

In this case, the order (from highest to the lowest) are as follows:

-30%, -27%, -24%, -23%, -22%, -21%, -20%, -19%, -18%, -16%

The look-back window has 500 observations, so the 99% VaR is given by the (1 – 0.99)500 + 1 = 6th worst observation.

Thus, monthly VaR = 21% * $100,000 = $21000

A is incorrect. The result is obtained by taking the sixth unordered observation as given in the question, i.e., -20%

B is incorrect. The result is obtained by calculating the 99% VaR as the 5^th worst observation, i.e., (1 – 0.99)500

D is incorrect. The result is obtained by taking the 5^th unordered observation as given in the question, i.e., -20%

The correct answer is: B).

ABC is the market maker in these transactions. The table gives bid-ask quotes in basis points. The bid price is the amount that the market maker is prepared to spend to purchase CDS protection and the ask (offer) price is the amount the market maker is prepared to accept to sell such protection.

In the first transaction, ABC is willing to sell protection to CFC with respect to Z at 112 basis points per year.   Thus,   the   annual   premium   payable   by   CFC  is   CAD   4,480,000   (\(= \frac{112}{10,000}\times\   \text{CAD}\  400,000,000\)). Recall that 1 basis point = 0.01%.

In the second transaction, ABC will buy the protection offered by CFC at 28 basis points per year. Thus, the annual premium receivable by  CFC is CAD 1,680,000 (\(= \frac{28}{10,000}\times \  \text{CAD}\  600,000,000\)).

In the final transaction, ABC will buy the protection offered by CFC at 42 basis points per year. Thus, the annual premium receivable by  CFC is CAD 840,000 (\(= \frac{42}{10,000}\times \  \text{CAD}\  200,000,000\)).

Thus,

$$\text{Net Annual Premium} = 4,480,000 – 1,680,000 – 840,000 =\text{CAD}\ 1,960,000\  \text{or CAD}\  1.96\  \text{million}$$

The correct answer is: D).

Let:

• \(d_t\) denote the probability of default by the end of year \(t\).
• \(s_t\) denote the probability of survival to the end of year \(t\)
• \(C_t\) denote the cumulative default rate to the end of year \(t\)

Therefore,

$$\begin{align} d_1 &= 0.400\%\\ d_2 &= 0.500\%\\ d_3 &= 0.600\%\end{align}$$

The probability of survival to the end of year 1,

$$S_1 = 1 – d_1 = 1 – 0.004 = 0.996$$

The cumulative default rate at the end of year 1,

$$C_1 = 1  – S_1 = 1 – 0.996 = 0.004$$

The probability of survival to the end of year 2,

$$S_2 = S_1 \times  (1 – d_2) = 0.996(1 – 0.005) = 0.99102$$

The cumulative default rate to the end of year 2,

$$C_2 = 1 – S_2 = 1 – 0.99102 = 0.00898$$

The probability of survival to the end of year 3,

$$S_3 = S_2 \times  (1 – d_3) = 0.99102 \times (1 – 0.006) = 0.98507$$

The cumulative default rate to the end of year 3,

$$C_3 = 1 – S_3 = 1 – 0.98507 = 0.014926$$

The correct answer is: C).

According to Regulation T of the Federal Reserve Board, one may borrow up to 50 percent of the purchase price of securities that can be purchased on margin. Therefore, the margin loan will be $1,500,000 (\(= \$3,000,000 \times 50\%\)). The remaining $1,500,000 has to be financed by equity. The leverage ratio is calculated as total assets divided by equity. Therefore, the hedge fund’s leverage ratio is 2.0 (\(= \frac{\$3,000,000}{\$1,500,000}\)).

Note: By buying on margin, you borrow money from a broker. Margin accounts increase an investor’s purchasing power and allow them to use other people’s money to increase financial leverage.

The correct answer is: B).

The value of the CDS is mainly determined by the default probability of the reference entity, in this case, Groningen Bank. However, it’s also determined by the joint default correlation of Groningen Bank and Bundesliga Bank. Since the default probability of the reference entity has increased, the CDS spread widens. With the increase in correlation between Groningen and Bundesliga increasing, the present value of the CDS for the investor would fall. The investor also has a wrong-way correlation risk. The exposure to Groningen increases, and it’s more unlikely that Bundesliga Bank will pay the default insurance.

The correct answer is: B).

It is apparent the customer is most likely not interested in trading stocks because he has very few questions about investing. What’s more, he doesn’t seem interested in finding out what the charges are, a typical question one would expect from a typical trader intent on keeping a large share of their profits. That he has traveled such a large distance to open an account at a faraway branch also raises questions because there likely could have been other banks closer to the address given, offering similar services.

However, there would be nothing wrong with opening multiple accounts – as long as the client’s identification documents are authentic and the purpose for each account is apparent.

The correct answer is: D).

James must disclose this information to his team head to forestall any fraudulent attempt by the new fund manager. It has been observed that ignoring such information results in the occurrence of more notorious fraud, some of which at times results in the closing of funds. Such information must be shared promptly.