Hi

@David Harper CFA FRM
Your post and video above are very useful thanks.

The one piece I'd still need a hand with please is the difference between Marginal PD as found in the Excel sheet from here:

https://www.bionicturtle.com/forum/...-survival-time-and-z-spread.10598/#post-55132
Where:

Marginal PD = Hazard Rate * e^(-Hazard Rate * T)

Row 9 in my Excel sheet below.

As opposed to in the video above where:

Marginal PD is another name for Conditional PD = Unconditional PD(T) / Cumulative Survival(T-1)

Row 16 in my Excel sheet below.

I've attached an Excel sheet which is based on the one I linked above, and you can see the values in row 9 & 16 differ for the 2 Marginal PD calcs. (It's still a work in progress, so sorry about that.)

Also, from what point in time is the perspective for the row 9 Marginal PD?

Thanks!

Karim

Hi

@David Harper CFA FRM
I'm feeling pretty dense, but I'm still not getting it

Aside from my question above, in the GARP 2018 P2 Question 6 we got another PD question and I thought "Unconditional Probability is a probability that does not take into account any other information, knowledge, or evidence" (from

https://www.quora.com/Whats-the-difference-between-conditional-and-unconditional-probability [In my desperation I looked on the web too.]), so when they ask "What is the probability that the bond survives for 3 years and then defaults during Year 4?" in my mind it meant that you knew about the 3 year survival, so it was a Conditional probability. i.e. it's not asking for the probability of default in year 4 without knowing anything else (although I guess if you're defaulting in year 4, you must have survived the first 3 years. Argh! I don't get it).

I had a look in the forum but couldn't find a Conditional vs Unconditional Probability for Dummies post

I feel like I'm wasting your time now, but would appreciate your thoughts before I give up on the topic (at least for the exam on the 19th).

Thanks

Karim

Full question & answer below for ease of searching:

6. A risk analyst at a mid-size hedge fund is evaluating the credit risk of several trade positions. The hedge

fund specializes in corporate debt and runs a strategy that utilizes both relative value and long-only trades

using CDS and bonds. One of the new trades at the hedge fund is a B-rated long bond valued at

JPY 10 billion. Some of the hedge fund’s newest clients, including the B-rated bond holders, are restricted

from withdrawing their funds for four years. The analyst is currently evaluating the impact of various

default scenarios to estimate future asset liquidity. The analyst has estimated that the conditional

(marginal) probability of default of the B-rated bond is 7.7% in Year 1; 7.1% in Year 2; 6.6% in Year 3; and

6.1% in Year 4. What is the probability that the bond survives for 3 years and then defaults during Year 4?

A. 4.9%

B. 5.7%

C. 6.1%

D. 6.9%

Correct answer: A

Explanation:

A is correct. The probability that the bond survives for 3 years and then defaults in Year 4 can be

modeled as a Bernoulli trial given by the following equation, where MP stands for marginal probability:

P (Default at end of Year 4) = (1 – MP Year 1 default)*(1 – MP Year 2 default) * (1 – MP Year 3

default)* (MP Year 4 default) = (1 – 0.077)*(1 – 0.071)*(1 – 0.066)*(0.061) = 0.0489 = 4.9%.

B is incorrect. It is the probability that the bond defaults in Year 3.

C is incorrect. 6.1% is the marginal default probability in Year 4.

D is incorrect. The probability is incorrectly derived: 6.9% = [1 – (1-0.077)(1-0.071)(1-0.066)(1-

0.061)]1/4; or 6.9% = [(1+0.077)(1+0.071)(1+0.066)(1+0.061)]1/4 – 1.

garp18-p2-6

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