Default Probability (PD)
Annualized probability of issuer default, implied from credit spread and assumed recovery rate.
The market-implied default probability is derived from credit spreads: PD ≈ Spread / (1 − Recovery Rate). This is the simplified CFA approach (risk-neutral PD). Example: 150 bp spread, 40% recovery → PD = 0.0150 / 0.60 = 2.5% annually. Key assumptions: constant hazard rate, spread = pure credit compensation (no liquidity premium). In practice, CDS-implied PDs are more accurate. Recovery rate varies by seniority: senior secured ~65%, senior unsecured ~40%, subordinated ~25%. Think of it as the break-even default rate that justifies the spread over Treasuries.
DV01
Dollar change in value for a 1 basis point (0.01%) yield move.
CS01
Dollar change in value for a 1 basis point move in credit spread.
Macaulay Duration
The weighted average time (in years) to receive the bond's cash flows.
Modified Duration
Measures the percentage price change for a 1% yield change.
Convexity
Measures the curvature of the price-yield relationship — how duration itself changes.
Stress Test (Rate Shock)
Estimates impact of large yield moves using duration and convexity.