Suppose there is a one-year government bond that costs 96.15 today and pays 100 next period. There is also a one-year bond issued by IT Consulting, a start-up firm, which costs 76.92. This bond will pay 100 if the firm still exists next period, and will pay zero if it goes bankrupt in the meantime.
(a) Suppose IT Consulting's success is independent of the business cycle. What is the probability that the firm will fail between now and one year from now?
(b) Suppose that IT Consulting's success is positively correlated with the general economic activity. Would this information change your assessment of the success probability, and if so how?