Question
A company owns one Baa-rated 4-year zero-coupon bond with a par value of $100. Suppose that the risk-free rate is 3% and the current credit
A company owns one Baa-rated 4-year zero-coupon bond with a par value of $100. Suppose that the risk-free rate is 3% and the current credit spread is 120 basis points (bps) so that the bond yield is 4.2% (all the rates are expressed with annual compounding). Five possible scenarios are available during the next month: a 0.40% chance of a rating of A (with a credit spread of 80 bps), a 99.12% chance that the rating will stay the same (with a credit spread of 200 bps), a 0.39% chance of Ba (with a credit spread of 300 bps), a 0.05% probability of B (with a credit spread of 500 bps), and a 0.01% chance that the bond will default (the bond is then worth $36). Compute the expected loss on the bond in next month. And what is the VaR if the confidence level is 99.8%?
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