The Pfiza healthcare company has issued one- and two-year annual coupon bonds with par value of $100. Both have coupon rates of 10% per year. The yields to maturity of the first and second bond are 6.5% and 6.8% (continuous compounding), respectively. The risk-free rate is 5%. The recovery rate is 35%. Defaults can only take place halfway through each year.

• Estimate the risk-neutral default probability in year one. 

• Estimate the risk-neutral default probability in year two.

Answer rating: 100% (QA)

To estimate the riskneutral default probability in year one we can use the concept of riskneutral pr... View the full answer