exercise: bond credit spreads

Discussion in 'P1.T3. Financial Markets & Products (30%)' started by fullofquestions, Sep 28, 2009.

  1. fullofquestions

    fullofquestions New Member

    The market trades a 1-year bond at 50bp credit spread, and a 3-year bond at 60bp. In the USD market conditions as of fall 2001 and with a recovery rate of 50%, what is the implicit probability of default before year 3?
    a. 1%
    b. 2% (ANS)
    c. 3% (ANS)
    d. 4%

    At the moment, I have not seen a problem of this type before, so any equations/tips appreciated. Also, don't know why the answer is both b and c. Any thoughts?

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