Anna Lebedeva is a fixed- income portfolio manager. Paulina Kowalski, a junior analyst, and Lebedeva meet to review several positions in Lebedevas portfolio. Lebedeva begins the meeting by discussing credit rating migration. Kowalski asks Lebedeva about the typical impact of credit rating migration on the expected return on a bond. Lebedeva asks Kowalski to estimate the expected return over the next year on a bond issued by Entre Corp. The BBB rated bond has a yield to maturity of 5.50% and a modified duration of 7.54. Kowalski calculates the expected return on the bond over the next year given the partial credit transition and credit spread data in Exhibit 1. She assumes that market spreads and yields will remain stable over the year. Exhibit 1 One- Year Transition Matrix for BBB Rated Bonds and Credit Spreads AAA AA A BBB BB B CCC, CC, C Probability (%) 0.02 0.30 4.80 85.73 6.95 1.75 0.45 Credit spread 0.60% 0.90% 1.10% 1.50% 3.40% 6.50% 9.50% Lebedeva next asks Kowalski to analyze a three- year bond, issued by VraiRive S.A., using an arbitrage- free framework. The bonds coupon rate is 5%, with interest paid annually and a par value of 100. In her analysis, she makes the following three assumptions: The annual interest rate volatility is 10%. The recovery rate is one- third of the exposure each period. The hazard rate, or conditional probability of default each year, is 2.00%