A company has one- and two-year bonds outstanding, each providing a

coupon of 8% per year payable annually. The yields on the bonds (expressed

with continuous compounding are 6.0% and 6.6%, respectively. Risk-free rates

are 4.5% for all maturities. The recovery rate is 35%. Defaults can only take

place halfway through each year.

a. Estimate the risk-neutral default probability in year one.

b. Estimate the risk-neutral default probability in year two.