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Use the following in formation for questions 4 6

Jennifer Barnett, a credit analyst with Begonia Partners, is valuing Azalea Companies 3-year, 6% annual coupon bond. Barnett collected par rates for government benchmark bonds and bootstrapped the spot rates below:

Maturity (Years)	Par Rate	Spot Rate
1	3.25%	3.25%
2	3.60%	3.61%
3	4.30%	4.34%

Assuming 15% volatility in interest rates, Barnett then calibrated a no-arbitrage binomial interest rate tree:

t = 0	t = 1	t = 2
		7.70%
	4.56%
3.25%		5.70%
	3.38%
		4.22%

Using the above, Barnett created a binomial tree to value the 3-year, 6% annual coupon Azalea bond on each coupon payment date (all values are per 100 par):

t = 0	t = 1	t = 2	t = 3
			100
		98.42
	100.76		100
104.73		100.28
	103.50		100
		101.71
			100

Barnett is now considering the impact of default risk on the Azalea bonds fair value. Her progress is in the table below:

Year	Hazard Rate	Recovery Rate	Exposure	Loss Given Default	Probability of Default	PV of Expected Loss
1	3.0%	60%	108.13	43.25	3.00%	missing
2	4.0%	60%	missing	missing	3.88%	1.54
3	5.0%	60%	106	42.40	4.66%	1.74

The expected exposure per 100 par at the end of year 2 is closest to:

A)104.29

B)106.17

C099.14

Refer to the information above

The credit valuation adjustment per 100 par for the Azalea bond is closest to:

A)4.54

B)4.92

C)5.11

Refer to the information above

All else equal, if the recovery rate decreased to 40%, the fair value of the Azalea bond would most likely:

A)decrease.

B)remain unchanged.

C)increase.

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