This paper proposes a two-factor hazard rate model, in
closd form, to price risky debt. The likelihood of
default is captured by the firm's non-interest
sensitive assets and default-free interest rates.
The distinguishing features of the model are
threefold. First, the impact of capital structure
changes on credit spreads can be analyzed. Second,
the model allows stochastic interest rates to impact
current asset values as well as their evolution.
Finally, the proposed model is in closed fom,
enabling us to undertake comparative statics
analysis, compute parameter deltas of the model,
calibrate empirical credit spreads, and determine
hedge positions. Credit spreads generated by our
model are consistent with empirical
observations.