A newly issued bond with 1 year to maturity has a price of 100, which equals its
Question:
A newly issued bond with 1 year to maturity has a price of 100, which equals its face value. The coupon rate on the bond is 15%; the probability of default in 1 year is 35%; and the bond’s payoff in default will be 65% of its face value.
a. Calculate the bond’s expected return.
b. Create a data table showing the expected return as a function of the recovery percentage and the price of the bond.
Step by Step Answer:
a The bonds expected return is 575 b ...View the full answer
Related Video
Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.
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