July 2011
Beginner
288 pages
7h 22m
English
Content preview from BOND MATH: The Theory Behind the FormulasBecome an O’Reilly member and get unlimited access to this title plus top books and audiobooks from O’Reilly and nearly 200 top publishers, thousands of courses curated by job role, 150+ live events each month,
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Implied Probability of Default on Coupon Bonds
In Chapter 2, we worked through the calculation of the implied probability of default on a zero-coupon corporate bond. We assumed that the amount the investor would be able to recover is a constant fraction of the risk-free value at the time of default. For a coupon bond, it is more common to set the recovery rate to be a constant fraction of the par value. But these are all arbitrary assumptions that can be changed to fit the circumstances; what matters for us is the approach to the bond math problem.
Suppose that the appropriate risk-free yield curve is flat at 3.50%. Then our 4-year, 4% annual payment corporate bond would be worth 101.837 (percent of par value) if there was no risk of default. ...
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