Submit your spreadsheet work (along with this summary answer sheet) for the problems below by the end of the exam period week. Indicate your bottom

Submit your spreadsheet work (along with this summary answer sheet) for the problems below by the end of the exam period week. Indicate your bottom line answers in the space provided below for each question (which require a spreadsheet model to determine the solution).

Problem: (a) (20) Consider the iTraxx Europe 5-year index (newly constituted). With quarterly payments and a quoted CDS spread on the index of 24 bps, find the corresponding constant conditional default probability (conditional on no default in earlier periods) expressed as a default intensity. Assume a 40% recovery rate and that the term structure of risk free rates is flat at 3.5%. (Hint: Refer to the technique used in the spreadsheet for Example 25.2 we are looking for the same default probability here, but with quarterly periods to facilitate the process described in Section 25.2. Consider reconstructing Hulls result for Example 25.2 as a check.)

(b) (20) Price the equity tranche of the iTraxx Europe 5-year index again with the assumptions stated above (and use your result from (a) for the constant hazard rate in equation (25.6), as in Example 25.2) but also assume a copula correlation of 0.15. Use an M=60 Gaussian quadrature to find the unconditional values necessary to determine the solution.

(c) (10) If the quoted price on the equity tranche was 11.25%, what is the implied compound correlation and what is the implied base correlation.