Question

In: Finance

The current 1-year spot rate on a treasury bill is 4.25% and the current 1-year spot...

The current 1-year spot rate on a treasury bill is 4.25% and the current 1-year spot rate on a BB-rated bond of equivalent risk to a prospective loan is 11.55%. The bond has a marginal probability of default in year 2 of 8.5% 11. What is the marginal probability of default in year 1? (3 points) 12. What is the cumulative probability of default over the 2 years? (4 points)

Solutions

Expert Solution

11

The formula to calculate marginal probability of default is given as:

Where is the risk free rate or spot rate on treasury bill and is the spot rate on risky asset. This formula is derived by assuming that an investor would be indifferent between return on a risky asset multiplied by its probability of repayment (which is equal to 1 - probability of default) and return on a risk less asset.

Substituting values given in the question, we get:

which is equal to 0.0654 or 6.54%

12

The formula to calculate cumulative probability of default is:

Where and are marginal probabilities of default in years 1 and 2 respectively. The intuitive sense of the formula is that we are trying to calculate the cumulative probability of repayment by multiplying probabilities of repayment in both years 1 and 2 and then we are subtracting that from 1 to calculate cumulative probability of default.

plugging in the values we get

or 14.48%

jeff jeffy answered 1 year ago
Next > < Previous

Related Solutions

Assume that the 1-year spot rate on a government bill is 5.25%, and the spot rate...
Assume that the 1-year spot rate on a government bill is 5.25%, and the spot rate for a 2-year bill is 5.75%. What is the par rate of a two-year bill? Round your answer to the nearest one-tenth basis point.
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the...
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:     1R1 = 1%, E(2r1) = 4.25%, E(3r1) = 4.75%, E(4r1) = 6.25% Using the unbiased expectations theory, calculate the current (longterm) rates for 1-, 2-, 3-, and 4-year-maturity Treasury securities. Plot the resulting yield curve. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the...
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 3.26%, E(2r1) = 4.70%, E(3r1) = 5.20%, E(4r1) = 6.70% Using the unbiased expectations theory, calculate the current (long-term) rates for 1-, 2-, 3-, and 4-year-maturity Treasury securities. (Do not round intermediate calculations. Round your answers to 2 decimal places.) 1 2 3 4
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the...
Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 2.54%, E(2r1) = 3.80%, E(3r1) = 4.30%, E(4r1) = 5.80% Using the unbiased expectations theory, calculate the current (longterm) rates for 1-, 2-, 3-, and 4-year-maturity Treasury securities. Plot the resulting yield curve.
Suppose that the current one-year rate (one-year spot rate) andexpected one-year T-bill rates over the...
Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 0.4%, E(2r 1) = 1.4%, E(3r1) = 1.9%, E(4r1) = 2.25% Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. (Round your answers to 3 decimal places. (e.g., 32.161))
Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the...
Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 0.5%, E(2r 1) = 1.5%, E(3r1) = 9.9%, E(4r1) = 10.25% Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year maturity Treasury securities. (Round your answers to 3 decimal places. (e.g., 32.161)) Current (Long-Term) Rates   One-year %     Two-year %     Three-year %     Four-year...
Treasury is: Spot 1-year Treasury is 4% Spot 2-year treasury is 4.5% B Corporate Debt interest...
Treasury is: Spot 1-year Treasury is 4% Spot 2-year treasury is 4.5% B Corporate Debt interest annually Spot 1 year 8.5%, Spot 2 years 9.5% Forward 1 Year maturity Let’s call the Treasury x The Corporate debt is called y What is the value of x the forward rate on one-year maturity Treasuries delivered in one year? What is the value of y the forward rate on one-year maturity B corporate debt delivered in one year? Exercising the term structure...
Is the current Treasury Bill Rate low or high? does the current interest rate make sense...
Is the current Treasury Bill Rate low or high? does the current interest rate make sense when you consider things such as the national debt, budget deficit, among other? Why or why not? . Is the shape of the treasury yield curve normal or abnormal?
1a. Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over...
1a. Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 0.3%, E(2r 1) = 1.3%, E(3r1) = 10.4%, E(4r1) = 10.75% Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. (Round your answers to 3 decimal places. (e.g., 32.161)) 1b.The Wall Street Journal reports that the rate on four-year...
Unbiased Expectations Theory Suppose that the current one-year rate (oneyear spot rate) and expected one-year T-bill...
Unbiased Expectations Theory Suppose that the current one-year rate (oneyear spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1=7%, E(2r1) =9%, E(3r1) =6.0% E(4r1)=4% Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. Show your answers in percentage form to 3 decimal places. Note that: Rate for a two year security = [(1 + 1R1)(1 + E(2r1))]...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT