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Investors are evaluating two 6-year bonds at time t in a financial crisis setting where there is a strong likelihood of default. Assume the following values for the probability of default (z) of the two bonds, issued respectively by companies A and B.
t+1 t+2 t+3 t+4 t+5 t+6 A 0.2 0.2 0.3 0.3 0.4 0.3 B 0.1 0.2 0.6 0.7 0.5 0.25
a. Assume both bonds are 6-year, 6% coupon, $1000 face value coupon bonds, each selling for $1000. Calculate the yields on the two bonds. Which is higher?
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