Suppose We Have a Zero Coupon Bond That Pays $1

Multiple Choice

Suppose we have a zero coupon bond that pays $1 after one year if the issuing firm is not in default. If the firm is in default, the recovery rate is 42%. The risk free interest rate for one year is 5%. If the credit spread on the bond is 2.5%, what is the risk-neutral probability of default of the bond? Assume all yields are stated in simple terms with annual compounding.

A) 0.01
B) 0.02
C) 0.03
D) 0.04