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)?
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
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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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