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Suppose the risk-free rate yield curve is flat at 2% with annual compounding. 1-year, 2-year, 3-year bonds yield are 3.00%, 3.50%, 3.9% respectively with annual compounding. All of the bonds pay 4% annual coupons. Assume that in case of default, the recovery rate is 30% of principal, with no payment of accrued interest. Find the risk-neutral probability of default during each year. yer Risk neutral default probability is given by - where y is Bond's yield 1-R For 1st year: 0.03 0.20 Default risk-neutral probability = - = 0.1428571 = 14.29 % 1-0.3 For 2nd year: 0.035 0.20 Default risk-neutral probability = - - = 0.2142857 = 21.43% lity = 10.3 = 0.2142897 For 3rd year: 0.039 0.20 Default risk-neutral probability = P = 0.2714286 = 27.14% 1 0.3