?Derivatives In finance, a derivative is a financial asset whose value is determined (derived) from a bundle of various assets, such as mortgages. Supp
Chapter 5, Problem 19(choose chapter or problem)
Derivatives In finance, a derivative is a financial asset whose value is determined (derived) from a bundle of various assets, such as mortgages. Suppose a randomly selected mortgage has a probability of 0.01 of default.
(a) What is the probability a randomly selected mortgage will not default (that is, pay off)?
(b) What is the probability a bundle of five randomly selected mortgages will not default assuming the likelihood any one mortgage being paid off is independent of the others? Note: A derivative might be an investment in which all five mortgages do not default.
(c) What is the probability the derivative becomes worthless? That is, at least one of the mortgages defaults?
(d) In part (b), we made the assumption that the likelihood of default is independent. Do you believe this is a reasonable assumption? Explain.
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