The government of countries A and B are thinking of issuing bonds to finance their spending. The bonds would have the same characteristics: maturity of 6 years, coupons of $100 each year, and face value of $4000. Country A expects the yield-to-maturity on its bonds to be 12% while country B expects the yield-to-maturity on its bond to be 11%. Suppose that both countries are identical except for their probability of default on their debt.

Part 1.) Which country do the investors think is less likely do default? Why?

Part 2.) Using the present value approach seen in class, find the prices of the bonds issued by the two countries.

Part 3.) If each country issues 200 bonds, how much money will they each raise? Is the most risky country raising the most money?

Part 4.) What would happen to the price of the bonds of country B if investors believe that the risk of default in country B decreases? Explain.