What is the probability of default implied by this price

Assignment Help Microeconomics

Reference no: EM13948743

Problem 1: This problem is a simpler version of what we discussed in class regarding the possible disconnection between YTM and the amount of wealth you accumulate over time when yield curves are not flat. You have $1,000,000.00 to invest in the following two bonds:

Bond A matures in two years and pays an annual coupon (once a year at the end of the year) of 1 percent. The face value is $1000.

Bond B matures in two years and pays and annual coupon (once a year at the end of the year) of 20 percent. The face value is $1000.

The zero yield curve is given below:

TTM Zero YTM
1 .03
2 .05
(TTM = time to maturity)

Questions:

1. If the market is risk neutral, what does the market expect the 1-year zero YTM will be next year?

2. What is the YTM for Bond A?

3. What is the YTM for Bond B?

4. In which Bond do you prefer to invest your $1,000,000? (Assume you can buy fractions of a bond, so that you don't have any cash leftover.)

5. For both bonds, you will get a cash flow next year (at t =1) from the coupon. If you reinvest the cash you get from coupons at the 1-year zero rate you will get next year, how much money will you have at t = 2 (given the reinvested coupons plus the final payment of principal and coupon) if the 1-year rate next year is the rate expected now (i.e., the rate equals your answer to question 1)?

6. How much do you get with each bond if the 1-year rate is .005 lower than is expected? What if the rate is .005 higher? Which bond is riskier? Which bond do you prefer?

Problem 2: The zero yield curve on STRIPS is given below.

TTM Zero YTM
1 .02
2 .022
3 .0225
4 .03
5 .035

There is a corporate bond that pays a 2% coupon (once a year at the end of the year) that is currently selling for $910 per $1000 in face value. What is the probability of default implied by this price if the recovery rate is 80%?

Reference no: EM13948743

Questions Cloud

Which audit company audited the annual report : What information does the Management Report (Not MD&A) convey? Which audit company audited the Annual Report? Is the MD&A audited?

Calculate the number of performances of each ballet required : Calculate the number of performances of each ballet required to produce the revenues needed to cover each ballet's direct fixed costs.

Compute the amount of net income for 2007 : Based on Eaton Corporation"s financial reports for fiscal 2007, it reported dividends declared and paid of $251 million for 2007. Compute the amount of net income for 2007. Eaton Corporation applies U.S. GAAP, and reports its results in millions o..

Describe the organization and the basic health care services : Choose a specific health care organization that has been in existence since the 1980s (e.g., a for-profit hospital by name; nonprofit hospital by name; governmental clinic; military or VA health care facility by name; Describe the organization and..

What is the probability of default implied by this price : There is a corporate bond that pays a 2% coupon (once a year at the end of the year) that is currently selling for $910 per $1000 in face value. What is the probability of default implied by this price if the recovery rate is 80%?

How this tree is represented as child/sibling implementation : how this tree is represented as child/sibling implementation?

Advantages and disadvantages of greek democracy : What were the advantages and disadvantages of Greek democracy

Determine the maximum speed : The bottle rests at a distance of 3 ft from the center of the horizontal platform. If the coefficient of static friction between the bottle and the platform is ms = 0.3, determine the maximum speed that the bottle can attain before slipping. Assum..

Management projects rapid growth-current value of the stock : Tre-Bien, Inc., is a fast-growing technology company. Management projects rapid growth of 30 percent for the next two years, then a growth rate of 17 percent for the following two years. After that, a constant-growth rate of 8 percent is expected. Th..

User Account

All Pages