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Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 24: Credit Risk Multiple Choice Test Bank: Questions with Answers 1. Suppose that the cumulative probability of a company defaulting by years one, two, three and four are 3%, 6.5%, 10%, and 14.5%, respectively. What is the probability of default in the fourth year conditional on no earlier default? A. 4.5% B. 5.0% C. 5.5% D. 6.0% Answer: B The unconditional PD for the fourth year is 14.5% minus 10% or 4.5%. The probability of no earlier default is 90%. The PD conditional on no earlier default is therefore 0.045/0.9=0.05 or 5% 2. Which of the following is usually used to define the recovery rate of a bond? The recovery rate for a bond is usually defined as the value of the bond immediately after a default as a percent of its face value. This is in spite of the fact that the bond holder’s claim in the event of a default in many jurisdictions is the face value plus accrued interest. 3. Which of the following is true? Risk neutral default probabilities are usually greater than real world default probabilities.

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