The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics. One year rate (%) Two Year rate (%) Gov’t bond 1.50 2.25 Company bond 3.00 4.25 Spread (risk premium) 1.50 2.00 The bank is unwilling to invest in any debt instrument with a probability of default greater than 2.25%. Should this bond be bought and held over two years (assume no cash payments in the event of default)?
The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics. One year rate (%) Two Year rate (%) Gov’t bond 1.50 2.25 Company bond 3.00 4.25 Spread (risk premium) 1.50 2.00 The bank is unwilling to invest in any debt instrument with a probability of default greater than 2.25%. Should this bond be bought and held over two years (assume no cash payments in the event of default)?
Excel Applications for Accounting Principles
4th Edition
ISBN:9781111581565
Author:Gaylord N. Smith
Publisher:Gaylord N. Smith
Chapter11: Bond Pricing And Amortization (bonds)
Section: Chapter Questions
Problem 7R
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Question
The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics.
|
One year rate (%) |
Two Year rate (%) |
Gov’t bond |
1.50 |
2.25 |
Company bond |
3.00 |
4.25 |
Spread (risk premium) |
1.50 |
2.00 |
The bank is unwilling to invest in any debt instrument with a probability of default greater than 2.25%. Should this bond be bought and held over two years (assume no cash payments in the event of default)?
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