FRM BK II (P.290) - Past FRM Exam Question 17

FRM
#1

Hi guys,

Could someone please explain how to derive the result to 16% from the question? It says the question is in 2013 practice FRM Exam. Thanks.

#2

Sam226, can you write the question? I will try to help you…

#3

Hi fbivictor,

The question is as follows:

Consider a 1-year maturity zero-coupon bond with a face value USD1million and a 0% recovery rate issued by company A. The bond is currently trading at 80% of face value. Assuming the excess spread only captures credit risk and that the risk-free is 5% per annum, the risk-metural 1-year probability of default on company A is closest to which of the following?

C) 16%

Why?

#4

Hi Sam,

Here is the answer:

Divide the qs. in 2 parts. Part 1- Find the Credit Spread

Apply the formula : CS= -1/(t-T)Log(D/F)-Risk Free Rate. The Credit Spread comes out to be 17.31%

Part 2- On Probability weighted basis this also must be the market price (expressed in %)

So form the eqn. PD x RR+ (1-PD) x (1-RR)= CS

Given, RR=0 , input the same and PD=16.31%.

Hope this helps.

#5

Thanks ABAL! I thought it was out of syllabus originally.