Find the value of the bond when it is issued

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Question: Consider a catastrophe bond with a 1 year maturity. Assume the principal amount is $1,000 and the coupon rate is 9%. Assume that the estimated expected loss as a percentage of the principal amount is 4%. That is, due to the possibility that the bond will be triggered (i.e., a catastrophe occurs), the expected payment to investors at the end of the year is $40 less than the promised payment. Assume that the one-year risk-free return is 3%. Also, assume that the required risk premium, i.e., the additional expected return above the risk-free return that investors require for the uncertainty associated with the bond's payoff is 2%. Use the discounted cash flow model to find the value of the bond when it is issued. Show your work and explain your logic.

Reference no: EM133359596

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