Birth:

Once upon a time, the treasurer of Mighty Corporation (MCO) decided to issue a bond (hereafter: The bond) The bond would have a 20-year life and promised that the holder of the bond would receive:

• 20 annual payments of $80,
• Along with the 20^th payment, MCO promised to return the principal of $1,000. In other words, the final payments received at maturity would be ($1000+$80) = $1080.

Years go by.

MCOs Treasurer was last seen with 2 suitcases of cash and a plane ticket for the Cayman Islands. The company is in serious financial trouble. Moodys drops the rating from AA to B (Junk). The insurance company sells the bond to a hedge fund with 9 years left to maturity for a YTM of 14%.

Summary: the bond has 9 years to maturity, a coupon of $80, a par value of $1000 and is trading with at YTM of 14%.

• A) What price did the insurance company receive for the bond?
• B) The hedge fund analyst believes that the bond will pay its remaining 9 coupon payments, but thinks the company will then go bankrupt and that it will pay just $500 of returned principal at maturity. Given what the fund paid for the bond, what YTM is the hedge fund actually expecting to receive?