Petra12345
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The 2-year asset swap spread for a company is 210bp. The underlying bonds provide a coupon of 8% per year (paid annualy). Risk free rate is 4,5%. The recovery rate is 35%. Default can take place half through each year. Estimate the risk neutral default rate each year?
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natninja
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(Original post by Petra12345)
The 2-year asset swap spread for a company is 210bp. The underlying bonds provide a coupon of 8% per year (paid annualy). Risk free rate is 4,5%. The recovery rate is 35%. Default can take place half through each year. Estimate the risk neutral default rate each year?
To be honest with you I'm guessing here as don't know much about credit risk but here's my guess - you know the Loss Given Default is 65%. You can apply the arbitrage free principle to get the risk neutral expected loss which would be the difference between the principle and the NPV (that's the bit I'm guessing at). Over a given timeframe, your expected loss = probability of default x loss given default so from that you can get the probability of default over the lifetime of the bond and divide by the number of years. That would work for the bonds not sure about the swap...
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