A fixed-income trader observes a three-year, 6.50% annual-pay corporate bond trading at 105.500 per 100 of par value. The research team at the hedge fund determines that the risk-neutral annual probability of default used to calculate the conditional POD for each date for the bond, given a recovery rate of 30%, is 1.5%. The government bond yield curve is flat at 3.00%.

A) Based on these assumptions, does the trader deem the corporate bond to be overvalued or undervalued? By how much? (To do this question you will need to calculate the risk-free value of the bond, and then the CVA as shown below.)

B) How does the yield spread of the bond compare to its theoretical spread?