First, calculate the credit spread: $s = \text{Yield} - \text{Risk-Free Rate} = 7\% - 3\% = 4\% = 0.04$. Next, estimate the average hazard rate ($\lambda$) assuming a constant recovery rate ($R$): $\lambda = \frac{s}{1 - R} = \frac{0.04}{1 - 0.40} = 0.06667$ Then, calculate the survival probabilities for Year 1 ($S_1$) and Year 2 ($S_2$): $S_1 = e^{-\lambda \times 1} = e^{-0.06667} \approx 0.9355$ $S_2 = e^{-\lambda \times 2} = e^{-0.13334} \approx 0.8752$ The unconditional probability of default occurring specifically in the second year is the difference between surviving the first year and surviving the second year: $PD_2 = S_1 - S_2 = 0.9355 - 0.8752 = 0.0603$