Consider Two Firms with One-Year Probabilities of Default Of $p _ { 1 } = 0.10$

question 6

Multiple Choice

Consider two firms with one-year probabilities of default of $p _ { 1 } = 0.10$ and $p _ { 2 } = 0.05$ , respectively. The conditional probability of default in one year is $\operatorname { Pr } \left[ D _ { 1 } \mid D _ { 2 } \right] = 0.7$ . What is the probability of a second-to-default basket option that pays $100 if any both firms default within a year? (Assume zero discount rates.)

• A) $0.50
• B) $1.50
• C) $2.50
• D) $3.50