CAS Exam 9 Spring 2016, Question 16
Study guide: Exam 9
A bank is considering acquiring a large portfolio of similar loans. The two portfolio options the bank is considering have the following characteristics:
| Portfolio A | Portfolio B | |
|---|---|---|
| Exposure | 100 million | 100 million |
| Average probability of default in 3 years | 1.5% | 3.0% |
| Estimated correlation between loans | 0.20 | 0.05 |
| Average Recovery Rate | 55% | 50% |
- Assume equal default rates for each loan within both portfolios.
- Assume equal correlation between each loan within both portfolios.
- Assume the Value at Risk (VaR) follows a Normal distribution.
Part a (1 point)
Using the 3-year 99% credit VaR as a decision framework, evaluate which portfolio the bank should acquire.
Part b (1 point)
The CRO wants to have a more robust analysis of the credit risks of the portfolios before making a decision. Discuss an alternative approach that would provide a more accurate assessment of the 3-year 99% credit VaR.
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