IAI Actuarial Core Principles · Economic Modelling · Simple models for credit risk
A zero-coupon bond issued by an Indian company has a constant hazard rate of 3% per year. Assuming default follows an exponential time, what is the probability that the company survives (does not default) for 5 years? Use e^-0.15 = 0.8607.
The five-year survival probability is exp(-0.03×5) = exp(-0.15), which is about 0.8607. With a constant hazard rate, survival declines exponentially, so the answer is not the simple linear 0.85, and 0.1393 is the default probability.
- A0.1393
- B0.8500
- C0.8607Correct
- D0.9700
- 0.7339
Explanation
With constant hazard λ, survival probability is exp(-λt) = exp(-0.03×5) = exp(-0.15) = 0.8607. Option 0 is the default probability (1-0.8607). Option 1 is the linear approximation 1-0.15, wrong because it ignores compounding.
Did you get it right without looking?
One question tells you little. A timed set on Simple models for credit risk shows your real accuracy, how long you take and where you lose marks.
More Simple models for credit risk questions
- Holding other Merton model inputs constant, which change would increase the credit spread on the firm's zero-coupon debt?
- Which statement about the Merton model is correct?
- In a simple credit risk model, which of the following correctly describes credit risk?
- In a simple model, a one-year zero-coupon bond has a risk-neutral default probability of q and a recovery rate of R fraction of face value. …
- A one-year zero-coupon corporate bond with face value Rs 100 trades at a continuously compounded yield of 8% p.a. The risk-free continuously…
- A one-year zero-coupon bond of face Rs 1,000 is issued by a firm. The risk-free annual effective rate is 5%. Under the Jarrow-Lando-Turnbull…