If a borrower has a default probability of 12% over one year, what is the probability of default over a month?

If a borrower has a default probability of 12% over one year, what is the probability of default over a month?
A . 12.00%
B . 1.00%
C . 2.00%
D . 1.06%

View Answer

Answer: D

Explanation:

Let theprobability of default over a month be p. Therefore the probability of survival at the end of 12 months would be (1 – p)^12. Since the one year probability of default is 12%, we know that the probability of survival is 88%. Putting (1 – p)^12 = 88% and solving for p, we get p = 1.06%. Therefore Choice ‘d’ is the correct answer.