What is the expected return of the risky corp bond

Reference no: EM13813118

Mr. Weiss just bought a zero-coupon bond issued by Risky Corp. for $870, with $1000 face value and one year to mature. He believes that the market will be in expansion with probability 0.9 and in recession with probability 0.1. In the event of expansion, Risky Corp. can always repay the debt. In the event of recession, the company would fail to meet its debt obligation. The bondholders would recover nothing and completely lose their investment, should the firm default. A zero-coupon government bond with the same maturity and face value is selling at $952.38. Assume that the government never defaults. The expected value and the standard deviation of the return of the market portfolio are 15% and 30%, respectively. Risky Corp’s bond return has a correlation of 0.67 with the market portfolio return. Assume that interest is compounded annually.

1. Suppose Mr. Weiss holds the bond to maturity. What will be his holding period return if Risky Corp. does not default? What will be his holding period return if the firm defaults?

2. What is the expected return of the Risky Corp. bond? Is the bond risky or risk free? Explain.

3. What is the YTM of the government bond? Is this YTM the risk free rate? Explain.

4. Compare the expected return of the Risky Corp. bond with the risk free rate. Would a risk-averse investor buy the Risky Corp. bond at $870? Explain.

5. The standard deviation of the return of the Risky Corp. bond is 34.48%. What is the beta of the bond? What would be the equilibrium expected return of the Risky Corp. bond if the CAPM holds? Does Mr. Weiss overvalue or undervalue the bond relative to the CAPM?

6. Suppose Mr. Weiss changes his mind and sells his Risky Corp. bond. He invests in a portfolio that allocates 50% of the money on the market portfolio, and the other 50% on the government bond. What are the expected value and the standard deviation of his portfolio return? Is his portfolio efficient? Explain.

Reference no: EM13813118

Questions Cloud

Interest rates affected when the riskiness of bonds rises : Using both the supply and demand for bonds and liquidity preference framework, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frame works?

Rate on the discounted loan : Acton can choose from two loan offers: $12,000 at 8% simple interest for 9 months; or a $12,000 9-month discounted loan at 7% discount. Based on the actual interest paid and the true rate on the discounted loan, which of the two loan offers will A..

How can this be used to maintain a competitive edge : Normal 0 false false false EN-US X-NONE X-NONE How can this be used to mai..

What is the expected return of the risky corp bond : Mr. Weiss just bought a zero-coupon bond issued by Risky Corp. for $870, with $1000 face value and one year to mature. He believes that the market will be in expansion with probability 0.9 and in recession with probability 0.1. In the event of expans..

Formulate a linear programming model : Formulate a linear programming model that can be used to determine the percentage that should be allocated to each investment idea.

Demonstrate an understanding of the performance : How the balanced scorecard is calculated. If you have questions on it, please do not email me, as the answer will be contained within these resources and it is crucial that you learn exactly how it works.

Create the overall meaning of the poem fire and ice : create the overall meaning of the poem "Fire and Ice" by Robert Frost. Choose one literal image and one bit of figurative language.

Write a program to calculate the outcome of a competition : The divers take turns, and when the competition is finished, they are ranked according to score. Write a program to calculate the outcome of a competition

User Account

All Pages