Question 5 Consider a bond that promises to pay coupons annually for 10 years. The...
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Question 5
Consider a bond that promises to pay coupons annually for 10 years. The face value is $1000. The riskfree rate is 2%. The coupon rate is 3%. The bond is currently trading at $463. Assuming that payments are deposited at the risk-free rate, compute the default probability p that the bond defaults during a period (t, t+1] given that there was no default during [0,t]; do this in the case where
a) the recovery rate is 0%: if the bond defaults, all future scheduled payments cease to exist. b) the recovery rate is 20%: if the bond defaults, a terminal payment equivalent to 20% of the face value is made at the time of default (and all future scheduled payments cease to exist).
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