Question

Which of the following statements pertaining to Mortality-rate derivation of credit risk is false?

Select one:

a. Mortality rate estimates are sensitive to the number of issues in each investment grade

b. Mortality rate estimates are sensitive to the sample period

c. Mortality rate approach is backward looking

d. Mortality rate approach is forward looking

e. Mortality rates are estimated from actual data on bond and loan defaults

Which one of the following statements is true?

Select one:

a. Duration decreases with the maturity of a fixed income security, but at a decreasing rate.

b. Duration decreases with the maturity of a fixed income security, but at an increasing rate.

c. Duration increases as the yield on a security increases.

d. Duration decreases as the coupon payment increases.

e. None of the listed options is correct.

Answer 1

Ans-1 Mortality rates reflect the historic default risk experience of a bond or a loan. It is a process similar to the one employed by insurance companies to price their policies.

Option (a) is correct as the mortality rate estimates ARE sensitive to the number of issues in each investment

Option (b) is correct as mortality rate estimates ARE sensitive to sample period

Option (c) is correct as this approach is backward looking as they reflect the historic default risk experience of bond or loan

Option (d) is Incorrect as the mortality rate approach is NOT forward looking, as explained in option (c) above

Option (e) is correct as the mortality rates are estimated from actual data on bond and loan defaults

Ans-2 Option (a) and (b) are incorrect as the duration my decrease at any rate for a fixed income security as that is quite unpredictable and depends on various circumstances.

Option (c) is incorrect as duration decreases as yield on security increases as the amount invested will be recoverd earlier as compared to lower yield.

Option (d) is Correct as duration decreases as the coupon payment increases as the amount invested will be recovered earlier as compared to the lower coupon rate.