*"Full E1.09. Suppose the rate on Company A’s one-year zero-coupon bond is 10.0% and the one-year T-bill rate is 8.0%. Assume the T-bill is riskless and the probability of default of Company A’s bond is 10%. What is the LGD of Company A’s bond?*

a. 18.18%

b. 81.82%

c. 20.01%

d. 79.99%

1+i = [(1-PD) * (1+k)] + [PD*(1+k)*(1-LGD)]"

a. 18.18%

b. 81.82%

c. 20.01%

d. 79.99%

1+i = [(1-PD) * (1+k)] + [PD*(1+k)*(1-LGD)]"

I wonder when I should instead use the spread to calculate LGD:

LGD = spead/PD = (10-2)/10 = 20% ?

For example Full II question 2:

*The risk-free rate is 5% per year and a corporate bond yields 6% per year. Assuming a recovery rate of 75% on the corporate bond, what is the approximate market implied one-year probability of default of the corporate bond?*

a. 1.33% b. 4.00% c. 8.00% d. 1.60%

CORRECT: B Using the approximation method, the 1-year probability of default is (6%-5%)/(1-0.75) = 4%

a. 1.33% b. 4.00% c. 8.00% d. 1.60%

CORRECT: B Using the approximation method, the 1-year probability of default is (6%-5%)/(1-0.75) = 4%

Does it mean we need to VERY careful about “approximate”? or does it mean that as long as the question provides 2 rates, i should not use spread to approximate?

Thanks