Which of the following is false?Single choice

Question Image
A

a. Adjustable rate mortgages have interest rates that adjust periodically according to the movement in some index.

B

b. The probability that a borrower would default in any specific time period is the marginal default probability.

C

c. The cumulative default probability of a borrower in a given time period is one minus the product of the marginal default probabilities for all time periods up to that time period.

D

d. A loan commitment is an agreement involving the amount of loan available and the amount of time during which the loan can be initiated.

E

e. A major advantage of discriminant models to assess the credit risk of a customer is the stability of the coefficient weights over time.

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You are estimating the probability of default for a given firm using the options model of default risk where this probability is given by Prob Default = N(-DD), and DD is the distance-to-default, calculated using the formula we covered in class. While implementing this model, you decided to consider the risk of default over a one-year horizon and set the face value of the debt in one year as the current book value of the debt. You also collected the following additional information on the firm: Current book value of debt = $190M Current market value of equity = $400M Equity volatility = 0.81 (measured during the past year) Value of D/A (measured during the past year) = 0.4 Moreover, you decided to use the simple approach described in class to compute the value of the firm’s assets and its asset volatility. Finally, you decided to set the value of 𝜇 equal to 5%. Following these steps, you first calculated DD and then determined the risk of default using the table below for the standard normal distribution. Standard Normal Distribution (Mean = 0, Std Dev = 1). P(Z ≤ z)          z 3.0%           -1.88 2.0%           -2.05 1.0%           -2.33 0.5%           -2.58 0.2%           -2.88 0.1%           -3.09            In this context, what can you say about the probability of default?

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