Credit risk measures using the reduced form model: assume a company has the following values for its debt issue.

Face value of the firms debt: K = $1,000

Time to maturity of the debt (tenor): T t = 1 year (T = maturity)

Default intensity (approx prob of default per year): = 0.03

Loss given default: = 0.3 (30%)

P(t,T) = 0.95

(a) Calculate the probability that the debt will default over the time to maturity.

(b) Calculate the expected loss.

(c) Calculate the present value of the expected loss.

Show all calculations All prices and interest rates must be expressed to three decimal places

I have added an example question below the way the professor wants his answers to be.

3. Credit risk measures using the reduced form model: assume a company has the following values for its debt issue. Face value of the firm's debt: K = $1,500 Time to maturity of the debt (tenor): T - t = 1 year (T = maturity) Default intensity (approx prob of default per year): 1 = 0.05 Loss given default: p = 0.35 (35%) P(t,T) = 0.95 (a) Calculate the probability that the debt will default over the time to maturity. Prob(TST) = 1 - E-UCT-1) = 1 - e-(0.05)(1) = 0.04877 = 4.877% (b) Calculate the expected loss. Expected loss = K[1 e-AY(T-1)] = 1500[1 e-(0.05)(0.35)(1)] = $26.022 (c) Calculate the present value of the expected loss. PV of loss given default = K P(t,T) - D(t, T) = KP(t,T)[1 e-A%CT-6)] = P(t,T)x K[1 - e-AYCT-t)] = P(t,T) x Expected Loss = (0.95) ($26.022) = $24.721