The following represents two yield curves. $$\begin{array} { | l | c | c | }
\hline \text { Maturity } & \begin{array} { c }
\text { Pure Discount } \
\text { Treasury Yields }
\end{array} & \begin{array} { c }
\text { B-rated Corporate Bond Yields } \
\text { (Pure Discount Bonds) }
\end{array} \
\hline 1 \text { year } & 3 \text { percent } & 6 \text { percent } \
\hline 2 \text { year } & 6 \text { percent } & 10 \text { percent } \
\hline 20 \text { year } & 12 \text { percent } & 17 \text { percent } \
\hline
\end{array}$$
-What is the expected probability of default in year 2 of two-year maturity B-rated debt?

Question

The following represents two yield curves. $$\begin{array} { | l | c | c | } 
\hline \text { Maturity } & \begin{array} { c } 
\text { Pure Discount } \
\text { Treasury Yields }
\end{array} & \begin{array} { c } 
\text { B-rated Corporate Bond Yields } \
\text { (Pure Discount Bonds) }
\end{array} \
\hline 1 \text { year } & 3 \text { percent } & 6 \text { percent } \
\hline 2 \text { year } & 6 \text { percent } & 10 \text { percent } \
\hline 20 \text { year } & 12 \text { percent } & 17 \text { percent } \
\hline
\end{array}$$
-What is the expected probability of default in year 2 of two-year maturity B-rated debt?

Quizplus · Accepted Answer

To determine the expected probability of default, we must first calculate the spread for the B-rated corporate bonds at a two-year maturity, which is (10% - 6%) = 4%.

Next, we use the historical default rates for B-rated corporate bonds at a two-year maturity, which is approximately 2.2%.

Finally, we can calculate the expected probability of default by multiplying the spread by the historical default rate:

Expected probability of default = 4% * 2.2% = 0.088% = 0.8843%

Therefore, the answer is C) 4.43 percent.

The Following Represents Two Yield Curves -What Is the Expected Probability of Default in Year 2