A five-year 2.4% defaultable coupon bond is selling to yield 3% (Annual Percent Rate and semi-annual compounding). The bond pays interest semi-annually. The risk-free yield is 2.4%. Therefore, its current credit spread is 3% -2.4% = 0.6%. Two years later its credit spread increases from 0.6% to 1% while the risk-free yield doesnt change. Assuming the face value of the coupon bond and risk-free bond is 100.

a)What is the return of investing in this bond over the two year? (10 marks)

b)If we define credit value as the difference between the prices of risk-free bond and defaultable bond, what is the current credit value of the bond, and what is it after two years? (10 marks)

c)Decompose the return into two components attributable to moving to maturity and the increase in the credit spread. (10 marks)