Credit risk

Question 1

(a) The spread between the yield on a three-year corporate bond and the yield on a similar

risk-free bond is 50 basis points. The recovery rate is 30%. Estimate the average hazard

rate per year over the three-year period.

(b) Suppose the spread between the yield on a five-year bond issued by the same company as

in (a) and the yield on a similar risk-free bond is 60 basis points. Assume the same

recovery rate of 30%. Estimate the average hazard rate per year over the five-year period.

What does your results indicate about the average hazard rate in years 4 and 5?