If the default hazard rate for a company is 10%, and the spread on its bonds over the risk free rate is 800 bps, what is the expected recovery rate?

If the default hazard rate for a company is 10%, and the spread on its bonds over the risk free rate is 800 bps, what is the expected recovery rate?
A . 40.00%
B . 20.00%
C . 8.00%
D . 0.00%

View Answer

Answer: B

Explanation:

The recovery rate, the default hazard rate (also called the average default intensity) and the spread on debt are linked by the equation Hazard Rate = Spread/(1 – Recovery Rate). Therefore, the recovery rate implicit in the given data is = 1 – 8%/10% = 20%.