From the Treasury strip yield curve, the current required yields on one- and two-year Treasuries are i1 = 4.65 percent and i2 = 5.50 percent, respectively. Further, the current yield curve indicates that appropriate one-year discount bonds are yielding k1 = 8.5 percent, and two-year bonds are yielding k2 = 10.25 percent.
a. Calculate the one-year forward rate on the Treasuries and the corporate bond.
b. Using the current and forward one-year rates, calculate the marginal probability of repayment on the corporate bond in years 1 and 2, respectively.
c. Calculate the cumulative probability of default on the corporate bond over the next two years.