Question

The 1-, 2-, 3-, 4-, and 5-year CDS spreads are $100,120,135,145$, and 152 basis points, respectively. The risk-free rate is $3 \%$ for all maturities, the recovery rate is $35 \%$, and payments are quarterly. Use DerivaGem to calculate the hazard rate each year. What is the probability of default in year 1 ? What is the probability of default in year 2 ?

   The 1-, 2-, 3-, 4-, and 5-year CDS spreads are $100,120,135,145$, and 152 basis points, respectively. The risk-free rate is $3 \%$ for all maturities, the recovery rate is $35 \%$, and payments are quarterly. Use DerivaGem to calculate the hazard rate each year. What is the probability of default in year 1 ? What is the probability of default in year 2 ?

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Options, Futures, and Other Derivatives

Options, Futures, and Other Derivatives

John C. Hull 10th Edition

Chapter 25, Problem 30

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Step 1

To calculate the hazard rate, we first need to calculate the survival probabilities for each year. The survival probability for year 1 is given by: $S_1 = \frac{1}{1 + \text{CDS spread}_1 \times \text{recovery rate}}$ $S_1 = \frac{1}{1 + 0.01 \times 0.35} = Show more…

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The 1-, 2-, 3-, 4-, and 5-year CDS spreads are $100,120,135,145$, and 152 basis points, respectively. The risk-free rate is $3 \%$ for all maturities, the recovery rate is $35 \%$, and payments are quarterly. Use DerivaGem to calculate the hazard rate each year. What is the probability of default in year 1 ? What is the probability of default in year 2 ?

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