Investors are evaluating two $7-$year, $7\%$ coupon bonds at time $t,$ issued by $2$ corporations in a

financial crisis setting where there is a strong likelihood of default. Assume the following values

for the probability of default $(z)$ of the two bonds, issued respectively by companies A and B $.$

a$.$ Assume both bonds are, $$1000$ face value coupon bonds, each of which has been bought at

$$1000$ before the risk is revealed. Calculate the approximate yields on the two bonds once

the risk is revealed, given the cash flow$/$average annualized return method. Which yield is

higher?

b$.$ Calculate the exact yields, given the technical method of your choice.

c$.$ Now assume an asset valuation setting where all future interest rates are exogenously fixed at

$5\%$; the prices of the bonds are to be determined. Determine the prices of bonds A and B

given the above information? Which is higher?

d$.$ Now, taking both present value streams together, does there exist some value for the yield $i$

that would make the price of Bond A equal to the price of Bond B$?$

e$.$ Suppose that very early in $t+1,$ many prominent analysts come to believe that Company $A$

will not make it past $t+3,$ and will default outright from that time. Since companies A and $B$

are not complementary, it is surmised that the default in A will actually lower the likelihood

of default in B to $0\mathrm{.}2.$ The revised expectation is as below.

Under this assumption, explain what should now happen to the yields and prices for A and B $.$