convertibility will render the approach unusable—but the
bondpricehastobeavailable.Ifthecorporatebondissueis
privately placed, this may not be feasible. Second, the
probabilitiesthatareestimatedmaybedifferentfordifferent
bondsissuedbythesamefirm.Someofthesedifferencescan
be tracedto theassumptionwehavemadethat theannual
probability of default remains constant, and others canbe
tracedtothemis-pricingofbonds.Third,aswiththeprevious
approach, failure to make debt payments does not always
resultinthecessationofoperations.Finally,weareassuming
thatthecouponiseitherfullypaidornotpaidatall;ifthereis
apartialpaymentofeither thecoupon orthefacevaluein
default,wewilloverestimatetheprobabilitiesofdefaultusing
this approach.
ILLUSTRATION 17.1: Estimating the Probability of
Bankruptcy Using Bond Price: Global Crossing
Inlate2001,GlobalCrossinghada12%couponbondwith
eight years to maturity trading at $653. To estimate the
probabilityofdefault(withaTreasurybondrateof5%used
as the risk-free rate):
Solving for the probability of bankruptcy,
16 we get
To estimate thecumulative probability of distressover 10
years: