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Lecture13 Probability of Default
Lecture13 Probability of Default
(1 y*)T
(1 f ) 1 T
• or
(1 y )
An example of calculating default prob
• We wish to compare a 10-year Treasury
bond and a 10-year zero issued by OGDC
which is rated A by PACRA. The respective
yields are 6% and 7%, using semiannual
compounding. Assuming that the recovery
rate is 45% of the face value, what does the
credit spread imply for the probability of
default?
Example cont..
• Using equation
(1 y )T
• Therefore, the (1 f ) 1 T
cumulative (1 y*)
probability of
defaulting during
(1 .03) 20
next ten years is (1 .45) 1 20
16.8%. (1 . 035)
0.09231 / .55
0.1678
Credit Derivatives
• Credit derivatives are the latest tool in the
management of portfolio credit risk