Calculation of Bankruptcy Probability Suppose a Linear Probability Model You

question 9

Multiple Choice

Calculation of Bankruptcy Probability Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = .18 (debt ratio) + .35 (profit margin)
You know a particular firm has a debt ratio of 35 percent and a probability of default of 8 percent. Calculate the firm's profit margin.

• A) 4.857%
• B) 8.163%
• C) 6.53%
• D) 8.00%

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Definitions:

Adverse Selection

A situation in which one party in a transaction has more or better information than the other, leading to an imbalance that can result in market inefficiency or failure.

Insurance Premium

The amount of money an individual or organization pays for an insurance policy, providing coverage against specific risks over a defined period.

Expected Loss

a calculation used in finance and insurance to estimate the average financial loss or cost associated with an investment or insurance policy over a period.

Adverse Selection

A situation in which one party in a transaction has more information than the other, leading to an imbalance and potentially poor market outcomes, commonly seen in insurance markets.