Consider Two Firms with One-Year Probabilities of Default Of $$p _ { 1 } = 0.10$$

question 14

Multiple Choice

Consider two firms with one-year probabilities of default of $$p _ { 1 } = 0.10$$ and $$p _ { 2 } = 0.05$$ ,respectively.The conditional probability of default in one year is $$\operatorname { Pr } \left[ D _ { 1 } \mid D _ { 2 } \right] = 0.7$$ .What is the probability of a second-to-default basket option that pays $100 if any both firms default within a year? (Assume zero discount rates. )

• A)$0.50
• B)$1.50
• C)$2.50
• D)$3.50

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Definitions:

Expected Returns

The average return an investor anticipates receiving from an investment, taking into account the probability of different outcomes.

Probability

A measure of the likelihood that an event will occur, often expressed as a number between 0 and 1, where 0 means impossibility and 1 indicates certainty.

Expected Income

The forecasted amount of money that an individual or entity anticipates receiving over a certain period.

Expected Expense

Anticipated costs associated with planned activities or purchases within a certain period.