You have collected following information about the firm XYZ:

• The firm issues a corporate bond: par value = $300, annual coupon = $50 (paid once a year), maturity = 2 years.

• The current total value of the firm (including equity and the debt) = $600.

• The firms future values follow a two-state path with up state growth multiple u = 1.50 and

  down state growth multiple d = 0.67 each year. The annual risk-free rate = 10%.

  Assume annual compounding and annual coupon payment.

1. (a) Calculate the price of the corporate bond. (20 points)

2. (b) There is a two-year Treasury bond with the par value of $300 and the annual coupon of $50.

   Suppose the annual spot rate curve is flat at 10%. Calculate the price of the Treasury bond. (5

   points)

3. (c) Which bond, the Treasury bond or the corporate bond, has a higher price and why? (5 points)

4. (d) Calculate the yield-to-maturity for both the Treasury bond and corporate bond. Which bond

   has a higher yield to maturity and why? (10 points)

5. (e) Calculate the credit spread for the corporate bond. (10 points)

6. (f) If the volatility of the firm value increases, should the credit spread of the corporate bond

   increase, decrease, or stay the same? Explain. (10 points)