If there is a probability p of default on a bond then the, Financial Management

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If there is a probability p of default on a bond then the

If there is a probability p of default on a bond, then the following equation: 1 + i = (1 – p)(1 + i + x) + p.(0) relates x, the risk premium on the bond, to p and i, the riskless rate of interest. Use this equation to solve the following:

a. If the probability of default is 2% (0.02), and the riskless rate is 3%, what is the borrowing rate (where the borrowing rate is the riskless rate plus the risk premium)?

b. If the borrowing rate is 10%, and the riskless rate is 2%, what is the probability of default?

c. If the probability of default is 4%, and the borrowing rate is 8%, what is the riskless rate?

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Financial Management: If there is a probability p of default on a bond then the

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