Question

Calculate the probability of repayment, risk premium, and total interest rate if the risk-free interest rate is 3%, the interest rate on a corporate bond is 18%, and the recovery rate is 90%.

Answer 1

We can calculate the desired result as follows

Risk Free Rate = 3%

Interest on Corporate bond = 18%

Recovery Rate = 90%

A) Probability of Repayment refers to the probability with which the person will make the repayment of the total loan which he borrows. in other words we can also refer this to as the amount recovered on the loan.

Here the recovery rate given is 90%, which means that if a person borrows $ 1,000 from a bank, then the person is expected to repay $ 900 and chances of default is $ 100.

So, the Probability of Repayment is equal to the recovery rate that is 90% or (90/100) or 0.9

B) Risk Premium = Total Interest rate on bonds - Risk Free rate

= 18 - 3

= 15%

C) Total Interest rate as per the given data is 18%.