For a corporate issuer, which of the following can be used to calculate market implied default probabilities?

For a corporate issuer, which of the following can be used to calculate market implied default probabilities?

I. CDS spreads

II. Bond prices

III. Credit rating issued by S&P

IV. Altman’s scoring model
A . III and IV
B . I and II
C . I, II and III
D . II and III

View Answer

Answer: B

Explanation:

Generally, the probability of default is an input into determining the price of a security. However, if we know the market price of a security, we can back out the probability of default that the market is factoring into pricing that security. Market implied default probabilities are the probabilities of default priced into security prices, and can be determined from both bond prices and CDS spreads. Credit ratings issued by a credit agency do not give us ‘market implied default probabilities’, and neither does an internal scoring model like Altman’s as these do not consider actual market prices in any way. Therefore Choice ‘b’ is the correct answer and the others are not.