Consider a BB-rated $100 face valued zero coupon debt security with one year to maturity and...

Consider a BB-rated $100 face valued zero coupon debt security with one year to maturity and zero recovery rate. Assume that the annual risk-free rate is 5% and the traded price is $80. The probability of default (PD) is closest to Select one: a. None of the other answers provided is correct. b. PD=8% c. PD= 16% d. PD= 84% e. PD= 19.04%

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Expert Solution

Gvien about aa BB-rated security,

Face value = $100

coupon rate = 0

Price = $80

years to maturity = 1

risk free rate rf = 5%

Recovery rate RR = 0%

So, Probability of default can be calculated using formula

PD = 1 - (1+rf)*(PV/FV) = 1 - 1.05*80/100 = 1-0.84 = 0.16 or 16%

So, option c is correct.

jeff jeffy answered 2 years ago

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