Question

QUESTION 16 The following table shows the probability of default (%) for companies starting with a particular credit rating. Time (years) 1 2 3 4 5 7 10 Aaa 0.000 0.013 0.013 0.037 0.104 0.241 0.489 Aa 0.022 0.068 0.136 0.260 0.410 0.682 1.017 A 0.062 0.199 0.434 0.679 0.958 1.615 2.759 Baa 0.174 0.504 0.906 1.373 1.862 2.872 4.623 Ba 1.110 3.071 5.371 7.839 10.065 13.911 19.323 B 3.904 9.274 14.723 19.509 23.869 31.774 40.560 Caa 15.894 27.003 35.800 42.796 48.828 56.878 66.212 Which of the statements is correct? Choose all that apply. The probability that a bond initially rated Aa will default during the first year is 0.022%. The probability that a bond initially rated B will default during the third year is 14.723%. The probability that a bond initially rated Baa will default by the end of the seventh year is 2.872%. If a company’s initial credit rating is low, default probabilities tend to increase with time.

Answer 1

The following statements given are correct:

1. The probability that a bond initially rated Aa will default during the first year is 0.022%.

2. The probability that a bond initially rated B will default during the third year is 14.723%.

3. If a company’s initial credit rating is low, default probabilities tend to increase with time.

The following statement is not correct:

"The probability that a bond initially rated Baa will default by the end of the seventh year is 2.872%."

Probability of default of this bond in seventh year is 4.623%