FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment
A bond trades with a credit spread of 240 bps over the risk-free rate. Assuming a recovery rate of 40% and using the credit triangle approximation, what is the implied annual hazard rate?
The credit triangle gives spread equal to hazard rate times loss given default. With a 240 bp spread and 60% loss given default, the hazard rate is 0.024 divided by 0.60, which is 4.00% per year.
- A2.40%
- B4.00%Correct
- C1.44%
- D6.00%
Explanation
Credit triangle: spread ≈ λ(1 − R), so λ = 0.024/(1 − 0.40) = 0.04. Using 2.40% ignores recovery, 1.44% multiplies by (1−R) instead of dividing, and 6.00% divides by R incorrectly (0.024/0.4).
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