- CFA Exams
- CFA Exam: Level II 2021
- Study Session 13. Fixed Income (2)
- Reading 36. Credit Default Swaps
- Subject 3. Basics of valuation and pricing

###
**CFA Practice Question**

Assume a hazard rate of 3% for the first interest payment of $50 (year 1), and a hazard rate of 5% for the second and final interest and principal payment of $1050 (year 2). The recovery rate is 45%.

B. 3%

C. 7.85%

What is the probability of receiving $22.5 in year 1 and $472.5 in year 2?

A. 2%

B. 3%

C. 7.85%

Correct Answer: C

100% - 97% x 95% = 7.85%

###
**User Contributed Comments**
7

User |
Comment |
---|---|

Truesilver |
How would you receive something in year 2, if the compNy already defaulted in year 1? |

myron |
It's a probability, @Truesilver. The question is correct. |

forestman3 |
I think your answer here is wrong --- the probability of default in both period = 100% - probability of both survive (97%x95%) - probability of 1st period survival, then 2nd period default (97%x5%) = 7.8015% Please correct this. |

Yarrstar |
Forestman3, math gives 3% in your calculation. |

jimmyvo |
The answer is correct. |

Logaritmus |
3% is correct. We can get 22.5+472.5 only when defaulting at first payment. If they asked us about propability of gettnig 472.5 on second payment C will be correct answear. |

xiaoniu |
you may default at first payment and then pay the full at second payment. The question is asking the probability for both events to happen. The 'default' means the borrower cannot make the scheduled payment, but it does not necessarily mean it cannot make the second payment. Treat them as independent events. Therefore, the answer is correct. |