Question
Suppose a bond that matures in one year issued by a corporation has a rating B. Given this rating, there is 80% chance that a
Suppose a bond that matures in one year issued by a corporation has a rating B. Given this rating, there is 80% chance that a firm will be unable to pay its obligation in full and can only pay 10% on its face value and only 20% chance that it can meet its full obligation. If the market rate of interest is 5%, then answer the following questions: (i) What price the investor will be willing to pay, given the face value of $1000 and coupon rate of 15%? (ii) What price the investor will be willing to pay for a default free government bond that promises to yield the same amount at the end of a year? (iii) What is the after tax yield for B-rated bond and default free government bond if the tax on interest income from B-rated bond is 38% and for default free bond it is 20%?
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