FRM Part II · FRM Exam Part II · Introduction to Credit Risk Modeling and Assessment
A firm has a constant hazard rate of 4% per year. Using the standard reduced-form model, what is the probability that it survives at least 3 years (approximately)?
With a constant hazard rate of 4%, survival over three years is exp(-0.12), about 88.7%. The cumulative default probability would be roughly 11.3%, so that figure is the complement rather than the survival probability.
- A88.7%Correct
- B12.0%
- C96.0%
- D11.3%
Explanation
Survival probability = exp(-λt) = exp(-0.04×3) = exp(-0.12) ≈ 0.8869. The 11.3% option is the cumulative default probability, 12.0% is simple λt, and 96.0% is one-year survival.
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