Skip to content

FRM Part II · FRM Exam Part II · Portfolio Credit Risk

In a Merton model, a firm has asset value V0 = 120, debt face value D = 100 due in one year, and the distance to default is computed as d2 = 1.00 under risk-neutral drift. Using N(-1.00) = 0.1587 and N(1.00) = 0.8413, what is the model risk-neutral probability of default?

The risk-neutral default probability equals N(-d2) = N(-1.00), which is 15.87%. Default happens when asset value ends below debt face value, and d2 measures standardized distance to that threshold. The 84.13% figure is the survival probability.

  1. A84.13%
  2. B15.87%Correct
  3. C31.74%
  4. D7.94%

Explanation

Default occurs if V_T < D. Under the risk-neutral measure this probability is N(-d2) = N(-1.00) = 0.1587. The 84.13% option is the survival probability (wrong sign). Doubling to 31.74% wrongly treats it as two-sided.

Did you get it right without looking?

One question tells you little. A timed set on Portfolio Credit Risk shows your real accuracy, how long you take and where you lose marks.

Practise Portfolio Credit RiskFree diagnostic mock

More Portfolio Credit Risk questions