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Consider this information for the next question: Here is your boss' unfinished analysis of some zero coupon bonds, as shown in the table. Your boss
Consider this information for the next question: Here is your boss' unfinished analysis of some zero coupon bonds, as shown in the table. Your boss assumes CF1 of each bond is Bernoulli-distributed. Zero Coupon Bonds CFO CF1 Probability of Expected at T = 0 Promised Worst Case Worst Case * Value of CF1 Expected Value Return * Bond 1 $66.0 $100.0 $50.0 0.5000 $75.00 0.1364 2 $89.0 $100.0 0.0450 $98.20 0.1034 3 $96.0 $100.0 $80.0 $99.60 0.0375 * Estimates In terms of of probability and statistics, which is the best way to characterize bond 1? We expect bonds of this type to provide a CF1 of $100 about 50% of the time. However, we believe that, during other times this class of bonds will provide a CF1 of just $50. So, on average for this type of investment we expect a CF1 of about $75. Because past performance does not guarantee future results, it is imprudent to say anything about the potential performance of this bond. We believe that the bond's price (CFO) and estimated return indicate that it is a High Yield bond. We expect bonds of this type to provide a CF1 of $100 about 50% of the time. However, we believe that, during other times this class of bonds will provide a CF1 of just $75. So, on average for this type of investment we expect about a 13.6% return. O We believe that the market price (CFO) of this bond (and others like it) is too high. We therefore recommend not purchasing this type of bond until market conditions become more favorable. O Our view is that, because the bond has a low expected-value return, it is a poor investment prospect
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