(40 points) Owen bank wants to estimate the probability of default of the firm Fizer....
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(40 points) Owen bank wants to estimate the probability of default of the firm Fizer. Fizer bonds have the following term structure as shown in the plot. Assume that if Fizer defaults, the recovery rate is 0. Answer the following questions: 1) Calculate the 1-year default probability of Fizer's bonds during year 1 (i.e., from the beginning of year 1 till the end of year 1), based on the term structure curve (Yield rates are expressed in APR). (10 points) 2) Calculate the marginal default probability of Fizer's loan during year 2 (i.e., from the beginning of year 2 to the end of year 2). (15 points) 3) Suppose during the financial crisis, the overall economy bears a higher unexpected risk. This higher risk implies that treasury bills should no longer be regarded as risk-free. Instead, treasury bills now have a default rate of 1% during year 1, and a default rate of 1.5% over the 2-year horizon. Assume that the term structure stays the same as in the above plot. In this case, re-calculate the 1-year default probability of Fizer's bonds during year 1. (15 points) Rate Fizer bond (A) 14% 12% T-bonds 11% 10% 1 2 Maturity (ye
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