Problem 3 (25 points): Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year. If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid. 3a (15 points). What price must investors pay for this bond to expect a 10% yield to maturity? Expected cash flows PV of expected cash flows The price today should be: Year 1 Year 2 Sum 3b (20 points). At that price, what is the expected holding period return? Standard deviation of returns? Assume that periodic cash flows are reinvested at 10%. At the end of two years, the following cash flows and probabilities exist: Final Cash Flow Probability Holding Period Return (HPR) Prob*(HPR - Exp. HPR)² Prob *HPR $0.00 0.2 0.2 0.6 The expected holding period return is: The standard deviation is: $132.00 $1,252.00
Problem 3 (25 points): Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year. If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid. 3a (15 points). What price must investors pay for this bond to expect a 10% yield to maturity? Expected cash flows PV of expected cash flows The price today should be: Year 1 Year 2 Sum 3b (20 points). At that price, what is the expected holding period return? Standard deviation of returns? Assume that periodic cash flows are reinvested at 10%. At the end of two years, the following cash flows and probabilities exist: Final Cash Flow Probability Holding Period Return (HPR) Prob*(HPR - Exp. HPR)² Prob *HPR $0.00 0.2 0.2 0.6 The expected holding period return is: The standard deviation is: $132.00 $1,252.00
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would not pay anything.
If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year.
If the company defaults in the second year, neither the final coupon payment nor par
3a. What price must investors pay for this bond to expect a 10% yield to maturity?
3b. At that price, what is the expected holding period return? Standard deviation of returns? Assume that periodic cash flows are reinvested at 10%.
At the end of two years, the following cash flows and probabilities exist:
Transcribed Image Text:Problem 3 (25 points): Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would
If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year.
If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid.
3a (15 points). What price must investors pay for this bond to expect a 10% yield to maturity?
Expected cash flows
PV of expected cash flows
The price today should be:
Year 1
Year 2
Sum
3b (20 points). At that price, what is the expected holding period return? Standard deviation of returns? Assume that periodic cash flows are reinvested at 10%.
At the end of two years, the following cash flows and probabilities exist:
Final Cash Flow
Probability
Holding Period
Return (HPR)
Prob*(HPR - Exp. HPR)²
Prob *HPR
$0.00
0.2
0.2
0.6
The expected holding period return is:
The standard deviation is:
$132.00
$1,252.00
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