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Unformatted text preview: Implied Default Rates from Credit Spreads FIN 327 - Prof. Hood 10/20/2009 As of Oct. is" 2010, the average yield on investment grade corporate bonds (Baa or higher) was 4.31% and for Speculative grade (below Baa) it was 7.90%. The yield for a S-year Treasury note was 1.14% on the same day. For some perspective, the average annual default rate for investment grade is 0.17% and is 3.82% speculative grade. Consider Bond A (investment grade) and B (speculative grade) that were issued on Oct. is" and are S- year bonds. Assume they have the same yield as the average. They were issued at par; therefore, the coupon rates are 4.31% and 7.90%, respectively. We want to decompose the credit spread In to the expected loss and risk premium portion and demonstrate that our assumption about the risk premium and Loss Given Default (LGD) have a large impact on the implied default rate from the credit spread....
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- Fall '10
- Approximation, bond pricing formula, LGD, Pricing formula, Total Discount rate