2. Consider the case of five possible rating states, A, B, C, D, and E. The states A, B, and C are initial bond ratings; D symbolizes first-time default; and E indicates default in the previous period. Assume that the transition matrix π is given by:

A 10-year bond issued today at par with an A rating is assumed to bear a coupon rate of 7 percent.

a. If a bond is issued today at par with a B rating and with a recovery percentage of 50 percent, what should be its coupon rate so that its expected return will also be 7 percent?

b. If a bond is issued today at par with a C rating and with a recovery percentage of 50 percent, what should be its coupon rate so that its expected return will be 7 percent?