Relationship between default probability and interest rates

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A finance company wants to analyze the relationship between the default probability and the interest rates that will be charged to clients under the assumption of risk neutrality. The interest rate charged to prime clients with no risk of default is 3% and the recovery ratio of bankrupt loans is 50% of the loan principal. Compute the rates that would be charged to clients for whom the probability of default is 10, 20, 30, 50, and 60 percent and plot the default probability against the risk premium above the prime rate.

Reference no: EM131447393

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