Hello David,
I think there are different approaches to calculating PD in terms of formulas to use,
PD = CS/(1-RR) and 1-((1+risk free rate)/(1+yield)
but would they give the same value of PD? because when I tried to calculate the PDs with the following assumptions, I get different values:
Risk free rate: 5%
Prob. of Default: 2%
Recovery rate: 40%
I don't know if I'm doing this right, but I used the first formula to get the CS (spread) first, which turns out to be 1.2% (0.02*(1-.4)), and I add the spread onto the risk free rate to get the yield (6.2%), but when I plug this number into the second formula (1-(1.05/1.062)), I get a different value for PD. Maybe I'm thinking in the wrong direction?
Thanks!
I think there are different approaches to calculating PD in terms of formulas to use,
PD = CS/(1-RR) and 1-((1+risk free rate)/(1+yield)
but would they give the same value of PD? because when I tried to calculate the PDs with the following assumptions, I get different values:
Risk free rate: 5%
Prob. of Default: 2%
Recovery rate: 40%
I don't know if I'm doing this right, but I used the first formula to get the CS (spread) first, which turns out to be 1.2% (0.02*(1-.4)), and I add the spread onto the risk free rate to get the yield (6.2%), but when I plug this number into the second formula (1-(1.05/1.062)), I get a different value for PD. Maybe I'm thinking in the wrong direction?
Thanks!