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IAI Actuarial Core Principles · Economic Modelling · Simple models for credit risk

A one-year zero-coupon corporate bond with face value Rs 1,000 trades at Rs 920. The one-year risk-free zero-coupon bond trades at Rs 950 per Rs 1,000 face. Using continuous compounding, what is the approximate credit spread?

The corporate continuously compounded yield is ln(1000/920)=8.34% and the risk-free yield is ln(1000/950)=5.13%. The credit spread is therefore about 3.2%.

  1. A2.2%
  2. B3.2%Correct
  3. C4.2%
  4. D5.2%
  5. 6.2%

Explanation

Corporate yield = ln(1000/920) = 0.08338. Risk-free yield = ln(1000/950) = 0.05129. Spread = 0.03209, about 3.2%. Using simple differences of price (30/950=3.16%) is close but not the continuous spread.

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