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Suppose each year you pay invest in some combination of a risk free bond and a bond with credit risk. Each $1 invested in the
Suppose each year you pay invest in some combination of a risk free bond and a bond with credit risk. Each $1 invested in the risk free bond redeems $1.02 at the end of the year. For each $1 invested in the bond with credit risk, it will repay $1.09 at the end of the year, unless it defaults. If the bond defaults, then you will only receive a recovery value of $0.30 (and no interest). The probability of default is 4%. What is the optimal weight (to the nearest 0.01) that you should invest each year in the bond with credit risk in order the maximize your expected long term growth rate
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