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1 (b) RLMD,T = -0.02 + 0.

54RS&P,t + Et
Explanation: the regression coefficients for a model specified by Y=b X + a + e are obtained using
the formula:
b = SXY/S2X In this example: SXY = 0.06, SX = 0.18, E(Y) = 0.11
Then: b = 0.06 / (0.18)2 = 1.85 a = E(Y) b*E(X) = 0.11 (1.85*0.07)= -0.02
Where represents the error them.
2 (c) Explanation: The T-test would not be sufficient to test the joint hypothesis. In order to test the
joint null hypothesis, examine the F-statistic, which in this case is statistically significant at the 95%
confidence level. Thus the null can be rejected.
3 (c) Explanation: The result would follow a Binomial distribution as there is a fixed number of
random variables, each with the same annualized probability of default. It is not a Bernoulli
distribution as a Bernoulli distribution would describe the likelihood of default of one of the
individual bonds rather than of the entire portfolio (i.e. a Binomial distribution essentially describes a
group of Bernoulli distributed variables). A normal distribution is used to model continuous variables,
while in this case the number of defaults within the portfolio is discrete.
4 (c) Explanation: Omitted variable bias occurs when a model improperly omits one or more
variables that are critical determinants of the dependent variable and are correlated with one or more
of the other included independent variables. Omitted bias results in an over or under estimation of
the regression parameters.
5 (b) One of the assumptions of the multiple regression model of least squares is that no perfect
multicollinearity is present. Perfect multicollinearity would exist if one of the regressors is a perfect
linear function of the other regressors.
None of the other choices are assumptions of the multiple least squares regression model.
6 (b) Given a 1-year marginal default rate of 5.93%, the 1-month marginal default rate is 1 (1
0.0593)1/12 = 0.00508.
The number of combinations of 2 bonds from 17 bonds is 17*16/2, and so the probability of exactly 2
bonds defaulting in the first month is: (17*16/2) * (0.00508)2 * (1 0.00508)15 = 0.325%
7 (b)

Substituting the various values of x and y, we get f(1,1)=k, f(1,2)=2k, f(1,3)=3k,

f(2,1)=2k, f(2,2)=4k, f(2,3)=6k, f(3,1)=3k, f(3,2)=6k, and f(3,3)=9k. Therefore,

k1 + 2k + 3k + 2k + 4k + 6k + 3k + 6k + 9k = 1

So that, 36k = 1 and k=1/36.

P(X+Y>5) = f(3,3) = 1/36 x 3 x 3 =

A = Event that the wife receives the mans letter

B = Event that the man does not receive a response from his wife

We need to find P (A|B). First, we know P (A) = 2/3. To get P (B), note that there are
three possible scenarios.

8 (d).

His letter does not get to his wife probability is 1/3.

Her response letter does not get to him 2/9 (= 2/3 * 1/3, probability that
she gets his letter times the probability that her letter gets lost)

Her response letter does get to him 4/9 (= 2/3 * 2/3, probability that she
gets his letter times the probability that her letter gets to him).

He does not receive a response in scenarios 1 and 2, so P (B) = 5/9

Next, we also know P (B|A) = 1/3 (if she receives the letter, she responds and so he only does
not get a response if the letter is lost which happens with probability (1/3)
Then, by Bayes rule, P (A|B) = P(B|A) * P(A) / P(B) = (1/3) * (2/3) / (5/9) = 2/5
Tree Diagram