Suppose that B = $500 and A₀ = $470,α = 9%,r = 4%,σ = 17%,and δ = 0.If T = 8,what is the recovery rate assuming true default probability?

Question

Quizplus · Accepted Answer

The recovery rate in the context of a default can be calculated using the formula for the present value of the recovery amount, which is B * e^(-rT), where B is the face value of the bond, r is the risk-free rate, and T is the time to maturity. Given B = $500, r = 4% or 0.04, and T = 8 years, the recovery rate is calculated as $500 * e^(-0.04*8) = $500 * e^(-0.32) ≈ $400. This calculation assumes the exponential decay of the bond's value over time due to the risk-free rate, independent of the default probability, σ, and δ, since these variables are not directly used in the recovery rate calculation provided.

Suppose That B = $500 and A₀ = $470,α =