Reference no: EM132870712

-Suppose that a three-year corporate bond provides a coupon of 7% per year payable semiannually and has a yield of 5% (expressed with semiannual compounding). The yield for all maturities on risk-free bonds is 4% per annum (expressed with semiannual compounding). Assume that defaults can take place every six months (immediately before a coupon payment) and the recovery rate is 45%. Estimate the default probabilities assuming (a) the unconditional default probabilities are the same on each possible default date and (b) the default probabilities conditional on no earlier default are the same on each possible default date

- A company has issued one- and two-year bonds providing 8% coupons, payable annually. The yields on the bonds (expressed with continuous compounding are 6.0% and 6.6%, respectively. Risk-free rates are 4.5% for all maturities. The recovery rate is 35%. Defaults can take place halfway through each year. Estimate the risk-neutral default rate each year.

- The value of a company's equity is $4 million and the volatility of its equity is 60%.The debt that will have to be repaid in two years is $15 million.The risk-free interest rate is 6% per annum. Use Merton's model to estimate the expected loss from default, the probability of default, and the recovery rate (as a percentage of the no-default value) in the event of default. (Hint: The Solver function in Excel can be used for this question as indicated in footnote 23.)