Laurentide Resorts is issuing commercial paper with 60 days to maturity.In case of default, the investor will lose the total amount.The quoted rate for the issue is 7%, and an equivalent government-backed security's rate is 6%.What is the probability of default?
A)0%
B)0.93%
C)1%
D)99.06%

Question

Quizplus · Accepted Answer

The probability of default can be calculated using the difference in yields between the commercial paper and the government-backed security, assuming the extra yield compensates for the risk of default. The yield difference is 1% (7% - 6%). For a 60-day maturity, this annual rate needs to be adjusted to a 60-day period, which is $ \frac{1\%}{365} \times 60 \approx 0.164\% $. However, since the investor loses the total amount in case of default, this calculation does not directly apply. Instead, the correct approach involves understanding that the yield difference reflects the market's pricing of the default risk over the period. The direct calculation of the probability of default from the given information is not straightforward without additional assumptions or models. The choice provided closest to a reasonable interpretation, given the lack of direct calculation method provided, is 0.93%, acknowledging a small but significant risk of default as perceived by the market.

Laurentide Resorts Is Issuing Commercial Paper with 60 Days to Maturity.In