The ABC Company has issued a $1,000, .05 bond with a four-year life.

The interest rate for default-free securities is now .05. Assume that the following probabilities of payment apply the probability of collecting in a given year is statistically independent of whether or not a collection occurred in the previous year; missed calculations are not made up:

(a) Assume that you are willing to pay the unexpected present value; what amount would you pay for this bond?

(b) If the investor pays the amount in (a), what is the approximate cost to the firm issuing the bond?

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Principal or Interest of Period 1 2 3 34 4 Probability of Collection Probability of No Collection 1.0 .0 .9 .1 65 .6 .4 .5