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Question 5 (25 points): An AAA-rated 4-year senior unsecured bond has face value $100 and pays an annual coupon at the rate of 6%. The credit transition from rating AAA to other rating may occur at the end of year. Use Credit Metrics model and the information in the following tables to calculate the 95% credit VAR. (Assuming the loss distribution is a normal distribution). Category Year 1 Year 2 Year 3 AAA 3.60 4.17 4.73 AA 3.65 4.22 4.78 A 3.72 4.32 4.93 BBB 4.67 5.25 4.10 5.55 BB 6.02 6.78 B 6.05 7.02 8.03 ССС 15.05 15.02 14.03 Table 1: One-year forward zero curves by credit rating category (%) Mean (%) 53.80 Standard Deviation (%) 26.86 25.45 Initial Rating Seniority Class Senior Secured Senior Unsecured Senior subordinated Subordinated Junior subordinated Rating at year end (%) A BBB BB В ССС 51.13 AAA AA Default 23.81 38.52 32.74 17.09 AAA 90.81 8.33 0.68 0.06 0.12 0 0 0 20.18 10.90 Table 2: Recovery rate by seniority class(% of face value) Table 3: Probability of state transition (%)