In: Finance
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%
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.