Assignment:
1) Consider a 1-year risky zero coupon bond issued by company A. Suppose that the probability of default (risk neutral) of A in 1-year is 0.5% and the recovery rate of the bond is 40%. Given riskless 1-year interest rate being 3% (continuously compounding), calculate the 1-year credit spread for company A.
2) Consider a 3-month European put option with a strike price of $100 on an underlying asset which has a current price of $90 and annualized volatility of 20%. The market interest rate is assumed to have a flat term structure so that the interest rate is a fixed quantity of 8%.
(a) Determine the option value by Black Scholes formula.
(b) What is the meaning of delta-normal approach to VAR for measuring risks of derivatives positions?
(c) What is the 99% daily delta-normal VaR in return of issuing this option? (Hint: z0.01=2.33)