Question

Default probability: Company X has borrowed $150 maturing this year and $50 maturing in 10 years....

Default probability: Company X has borrowed $150 maturing this year and $50 maturing in 10 years. Company Y has borrowed $200 maturing in five years. In both cases asset value is $140. Sketch a scenario in which X does not default but Y does.

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Answer #1

Observation of the question:

Company X has to pay two loans. One is due this year, amounting $ 150 and the other one is due after 10 years. So, there is a plenty of time to pay the second loan which is also relatively smaller amount ($ 50). Whereas Company Y payment is due in 5 years and it is also of significant amount (i.e. $ 200) comparatively.

Drafting a Scenario:

Considering Company X can pay the payment due this year i.e. $ 150 and other payment is of smaller amount i.e. $ 50 due after 10 years. Company Y exposes more risk in future in relation to Company X as the payment is more significant and it is due in short period of time compared to X who is having a good standing now to cover its liabilities.

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