Suppose We Have a Zero Coupon Bond That Pays $1

question 11

Multiple Choice

Suppose we have a zero coupon bond that pays $1 after one year if the issuing firm is not in default. If the firm is in default, the recovery rate is 42%. The risk free interest rate for one year is 5%. If the credit spread on the bond is 2.5%, what is the risk-neutral probability of default of the bond? Assume all yields are stated in simple terms with annual compounding.

• A) 0.01
• B) 0.02
• C) 0.03
• D) 0.04

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Definitions:

Total Profit

The total income a business obtains after accounting for all expenses, taxes, and costs associated with its operations.

Herfindahl-Hirschman Index

A concentration measure used to calculate the level of competition within an industry by summing the squares of the market shares of all firms within the industry.

Concentration Ratio

A measure used in economics to assess the degree of market concentration, often indicating the combined market share of the top firms in an industry.

Herfindahl-Hirschman Index

A measure of market concentration to evaluate the level of competition within an industry.