Hooli Inc. issues a zero coupon bond with one year to maturity, priced at $930.972500 per $1,000 face value.

 (a) If investors demand a 4.55% expected return on the bond (effective annual rate with simple compounding), and the default probability at the end of the year is 2.24%, what is the implied recovery amount per $1,000 face value in the event of a default?

 (b) A credit default option written on the Hooli bond promises that in the event of a default, the option writer will pay the difference between the face value of the Hooli bond and its recovery value, in exchange for an upfront fee. 

Based on the analysis above and the assumption of no arbitrage, what would be the upfront fee to buy protection on $100,000 face value of the bond?

Answer rating: 100% (QA)

To solve this problem we can use the concept of expected loss and riskneutral valuation Lets calcula... View the full answer