Estimate the risk-neutral default probability

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a. A company has one- and two-year bonds outstanding, each providing a coupon of 8% per year 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 half-way through each year. Estimate the risk-neutral default probability each year.

b. Suppose that a bank has a total of $10 million of exposures of a certain type. The one-year probability of default averages 1.5% and the recovery rate averages 40%. The copula correlation parameter is 0.25. Estimate the 99.5% one-year credit VaR.

Reference no: EM133061299

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