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ACCOUNTING AND FINANCIAL ENGINEERING - EXAMPLE 34.1 : (i) In the pricing of engineering bonds, 3 sets of data for Portfolio Value, Probability, Senior Tranche and Junior Tranche are : \$2000, 81 %, \$1000, \$1000; \$1000, 18 %, \$1000, \$0; \$0, 1 %, \$0, \$0. By assuming independent defaults, find the price for : (a) Senior Tranche; (b) Junior Tranche. (ii) Assuming statistical independence of the values in the sample, the standard deviation of the mean (S) is related to the standard deviation of the distribution (s) by : N x S x S = s x s, where N is the number of observations in the sample used to estimate the mean. In a drug development project, let s = 1. Find the value of S if such a similar project is performed 100 times.

ACCOUNTING AND FINANCIAL ENGINEERING - ANSWER 34.1 : (i)(a) Price for Senior Tranche = 99 % x \$1000 + 1 % x \$0 = \$990. (b) Price for Junior Tranche = 81 % x \$1000 + 19 % x \$0 = \$810. (ii) Let N = 100, s = 1. Then S x S = s x s / N = 1 / 100, S = 1 / 10. The answer is given by Kang Chuen Tat; PO Box 6263, Dandenong, Victoria VIC 3175, Australia; SMS +61405421706; chuentat@hotmail.com; http://kangchuentat.wordpress.com.

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