Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would not pay anything.
If the company survives the first year, paying the annual coupon payment, it then has a 25% chance of defaulting in the second year.
If the company defaults in the second year, neither the final coupon payment nor par value of the bond will be paid.
3a . What price must investors pay for this bond to expect a 10% yield to maturity?
	Year 1	Year 2	Sum
Expected cash flows	120	1120
PV of expected cash flows
The price today should be:
3b . At that price, what is the expected holding period return? Standard deviation of returns? Assume that periodic cash flows are reinvested at 10%.
At the end of two years, the following cash flows and probabilities exist:
	Final Cash Flow	Holding Period Return (HPR)		Prob*(HPR - Exp. HPR)2
Probability			Prob *HPR
0.2	$0.00
0.2	$132.00
0.6	$1,252.00
The expected holding period return is:
The standard deviation is: