Notes, summaries, assignments, exams, and problems for Mathematics

Distribution of Moody's Ratings

Historical Default Rates

• Rating Agencies
• Default rates from bonds
• Market Data

CAPM Model for Bond Returns

The usual CAPM has to be modified to include expected loss per year.

What must the β be to justify the excess spread for Baa Bonds?

Merton's Model

A Structural Model That Predicts Default Rates

How Do We Find V₀ and σ_V?

We know E₀ and σ_E, and

An application of Ito's lemma shows

These allow us to find V₀ and σ_V from E₀ and σ_E.

Default Correlation

Defaults: If Firm A Defaults, is Firm B More Likely to Default Too?

No Default Correlation

Consider two firms, X and Y:

Q_X = 0.1, Q_Y = 0.2

If X and Y are uncorrelated, then the probability that they both default is Q_X × Q_Y = 0.02

Building Default Correlation

If X and Y are correlated,... Continue reading "Understanding Bond Default Rates and Correlation" »

Final Exam Cheat Sheet

Machine Rate Problems

Chapter 1: Categorical (Qualitative) Data

What is Categorical Data?

Categorical data describes the qualities of individuals or objects, rather than quantities. It's about characteristics that can be grouped into categories.

Examples of Categorical Data:

• Hair Color
• Preferred Clothing Brand
• Nationality

Visualizing Categorical Data:

Categorical data is often displayed using:

• Bar Charts
• Pie Charts
• Tables

Chapter 2: Quantitative Data

What is Quantitative Data?

Quantitative data deals with numbers and measurements. It allows for comparisons and mathematical operations.

Examples of Quantitative Data:

• Height
• Weight
• Age

Visualizing Quantitative Data:

Quantitative data is often presented using:

• Dot Plots
• Stem Plots
• Histograms

Measures of Center

• Mode: The most frequent value

Bond Price Sensitivity

7.7 Interest rate sensitivity. An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and an 8% yield to maturity on the purchase date. Immediately after the investor purchased them, interest rates fell, and each of them had a new YTM of 7%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table:

N=10 Y=8 or 7 PV=? FV=1000 PTM=0 except coupon=100

Default Risk Premium

6.4 Default risk premium. A treasury bond that... Continue reading "Bond Price Sensitivity and Default Risk Premium Analysis" »

Loan Amortization and EAR: You want to buy a car, and a local bank will lend you $40,000. The loan will be fully amortized over 5 years (60 months), and the nominal interest rate will be 8% with interest paid monthly. What will be the monthly loan payment? What will be the loan’s EAR?

Using a financial calculator: N=60, I/YR=8/12=0.6667, PV=-40,000, FV=0. Solve for PMT: $811.06.

To calculate the EAR: EAR = (1 + nominal rate/m)^m - 1. In this case, EAR = (1 + 0.08/12)^12 - 1.0 = (1.00667)^12 - 1.0 = 8.30%.

Loan Amortization Example: Jan sold her house on December 31 and took a $10,000 mortgage as part of the payment. The 10-year mortgage has a 10% nominal interest rate, with semiannual payments beginning next June 30. Next year, Jan must report... Continue reading "Understanding Loan Amortization and Calculating EAR" »

Vocabulary

English Definitions

Leading questions: Questions that encourage someone to answer in a certain way.

Mutually exclusive: Not able to be true or correct at the same time.

Weight: To give something more importance than something else.

Incentive: Something that will encourage people to do something.

Respondent: Person who completes a survey.

Analyse: To examine closely.

Ambiguity: When something has more than one possible meaning.

Jargon: Words used by one group of people, that other people might not understand.

Feedback: Opinions about something.

Dropout rate: The percentage of people who stop the survey before they have completed it.

Spanish Definitions

Liderar preguntas: Preguntas que animan a alguien a responder de cierta manera.

Mutuamente excluyentes:

Statistical Moments

A moment is a specific quantitative measure that characterizes a distribution. Two distributions are equal if their moments are equal.

Types of Moments:

• Related to the origin (0 as a reference)
• Related to the mean (μ as a reference)

M_r = (Σ(X_i – O)^r.n_i)/N

Where:

• X: individual observations
• r: Order of the moment (Order zero: r=0, First order: r=1, Second order: r=2, Third order: r=3)
• O: Origin or reference point
• n: frequency of each observation
• N: total number of observations

Properties:

• All moments of r=0 are equal to 1.
• Moments related to the mean are frequently called central moments.
• Moments with reference point 0 are frequently called ordinary moments.
• The arithmetic mean corresponds to the ordinary moment of the first order (r=

) Hypotheses, Type I and Type II Errors, and Statistical Tests

For each of the following tests, state the hypotheses, identify if it is a right-, left-, or two-tailed test and write Type I Error and Type II Error pertaining to the problem.

1. a) A professor of statistics states that the average student spends 3 hours studying for the midterm exam. Ho: μ = 3 vs. Ha: μ ≠ 3 Two-tailed test Type I Error: Concluding the average student doesn’t study 3 hours for midterm when in fact that is false. Type II Error: Not concluding the average student doesn’t study 3 hours for midterm when in fact that is true.
2. b) A spouse stated that the average amount of money spent on Christmas gifts for immediate family members is above $1,200. Ho: μ = 1200 (or