Explanation:
Option C is the false statement. The term (exp[-λ*(u-1)/4] - exp[-λ*u/4]) is used to model the probability of default between periods (u-1)/4 and u/4 based on the hazard rate λ, not to adjust swap rates into spot rates.
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In regard to this equation, each of the following is true EXCEPT, which is false?
A
The 445 highlighted in GREEN reflects a five-year credit default spread of 445 basis points which the protection buyer pays to the protection seller
B
The exp(0.045*u/4) highlighted in YELLOW models the price of a risk-free zero-coupon bond maturing at time (t) where 4.5% is a continuously compounded, flat swap rate curve
C
The term highlighted in BLUE that is 1/2*(exp[-λ*(u-1)/4] - exp[-λ*u/4]) adjusts the swap rates into spot rates
D
The 0.60 highlight in ORANGE reflects the loss given default (LGD) assumption because the recovery rate assumption is 40%.