Abstract
This chapter reviews the fundamentals of credit and debt valuation, including what credit risk premium should be charged to an obligor with a specific probability of default, the effects of credit spreads and interest rates on bond and debt valuation, simulating a credit risk spread based on industry comparables, generating an internal credit risk tiered structure, valuing the profit-cost analysis of new debt or line of credit, quantifying the market value of risky debt and its volatility, pricing risky debt assuming mean-reverting interest rates, amortizing debt and simulating prepayment risks, quantifying debt sensitivity using durations and convexity, and valuing risky debt using a markets-based options approach assuming stochastic market variables. These models are illustrated using the Modeling Toolkit software. This model is used to determine the credit risk premium that should be charged above the standard interest rate given the default probability of this debt or credit's anticipated cash flows.
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