Consider a 3-year, 5.00% annual payment corporate bond (par=100). The bond carries a certain amount of credit risk with an annual default probability of 2.00% (the hazard rate) given a recovery rate of 33.33%. In the valuation, interest rate volatility would have to be taken into account. The interest rate volatility is assumed to be 10% in government bond yields over the next few years.

A. Compute the CVA and price of the bond without the credit risk (i.e., as a government bond);

B. Then use them to calculate the price of this risky corporate bond, using the government par curve given in Exhibit 1 and the binomial interest rate tree in Exhibit 2.

C. Compute the credit spread of this corporate bond.