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. What is the probability that it survives for 3 years without default, to the nearest 0.1%?
With a constant hazard rate of 4%, three-year survival probability is exp(-0.04 x 3) = exp(-0.12), about 88.7%. The cumulative default probability is the complement, 11.3%, and simply multiplying 4% by three ignores continuous compounding.
- A88.7%Correct
- B12.0%
- C11.3%
- D96.0%
Explanation
Survival probability = exp(-0.04 x 3) = exp(-0.12) = 0.8869, about 88.7%. The 11.3% option is the cumulative default probability, and 12.0% is the simple sum of hazard rates (3 x 4%).
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