12 Suppose that the risk-free zero curve is flat at 1.3% per annum with continuous compounding and that defaults can occur at times 0.25 years, 0.75 years, 1.25 years, and 1.75 years in a two-year plain vanilla credit default swap with semi-annual payments. Suppose that the recovery rate is 40% and the unconditional probabilities of default (as seen at time zero) are 1% at times 0.25 years and 0.75 years, and 1.5% at times 1.25 years and 1.75 years. (i) Estimate the credit default swap (CDS) spread in the example above. (ii) Evaluate why CDS markets provide an important barometer of the creditworthiness of corporate bond markets.

12 Suppose that the risk-free zero curve is flat at 1.3% per annum with continuous compounding and that defaults can occur at times 0.25 years, 0.75 years, 1.25 years, and 1.75 years in a two-year plain vanilla credit default swap with semi-annual payments. Suppose that the recovery rate is 40% and the unconditional probabilities of default (as seen at time zero) are 1% at times 0.25 years and 0.75 years, and 1.5% at times 1.25 years and 1.75 years. (i) Estimate the credit default swap (CDS) spread in the example above. (ii) Evaluate why CDS markets provide an important barometer of the creditworthiness of corporate bond markets.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 18P

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D6) Suppose that the risk-free zero curve is flat at 0.06 per annum with continuous compounding and that defaults can occur half way through each year in a new two-year credit default swap. Suppose that the recovery rate is 0.26 and the default probabilities each year conditional on no earlier default is 0.02 Estimate the credit default swap spread. Assume payments are made annually. Rates are quoted in numbers, i.e. 0.05 is 5% rate. Please write your answer also in numbers.
The real risk-free rate is 3.25%. Inflation is expected to be 4.25% this year, 4.55% next year, and 2.3% thereafter. The maturity risk premium is estimated to be 0.05 × (t - 1)%, where t = number of years to maturity. What is the yield on a 7-year Treasury note? Do not round intermediate calculations. Round your answer to two decimal places.
7. The real risk-free rate is 2.5% and inflation is expected to be 2.75% for the next 2 years. A 2-year Treasury security yields 5.95%. What is the maturity risk premium for the 2-year security? Round your answer to one decimal place.
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Consider that the probability of a reference entity defaulting during a year conditional on no earlier defaults to be 2%; assume that defaults always happen halfway through a year; payments made on a CDS are made once a year, at the end of the year; assume the risk-free rate is 5% with continuous compounding and the recovery rate is 40%. We will value a new credit default swap. We are buying protection on an entity. CDS is 3-years. What is the required spread for a new issue? A. 103.63bps B. 98.32bps C. 132.53bps D. 124.49bps
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