investors are risk neutral, Finance Basics

At t = 0, a 3-year, 7% coupon corporate bond with face value $1,000 is trading at a credit spread of 15%. The risk free rate is constant and equal to 4% for all maturities. The recovery rate on the corporate bond is 40% if a default occurs. At t = 0, the market believes that the probability of default in the first year, P1, is 20%, and the probability of default in the second year, P2, is 30%. Assume investors are risk neutral.
a)  At t = 0, what is the price of the bond?
b)  At t = 0, what is the market's belief about the default probability in the third year, P3?
c)  If you buy $10,000 present value worth of the bond at t = 0, and you will liquidate the position at t = 1, what is the expected total amount of money you will have at t = 1? (Note: you may answer this question using a long way or a very short way.)
d)  Suppose the same company also has a 3-year zero coupon bond outstanding with face value $500. The bond is junior to the previous bond, and the recovery rate is therefore 0%. What is the value of this junior bond at t = 0? (Hint: you need to use P1, P2, and P3.)

Posted Date: 3/16/2013 1:19:45 AM | Location : United States

Related Discussions:- investors are risk neutral, Assignment Help, Ask Question on investors are risk neutral, Get Answer, Expert's Help, investors are risk neutral Discussions

Write discussion on investors are risk neutral
Your posts are moderated
Related Questions
Explain the term - Underwriting Underwriting is an agreement whereby underwriter promises to subscribe to a specified number of debentures or shares or a specified amount of

what makes a preference shares a hybrid?

Logistics Management - Supply Chain Management The objectives of logistics management are to: Determine the best routes to market; air, rail or road Determine if w

Role of Stock Exchange in Economic Development The Roles of Stock Exchange in Economic Development are as follow: 1. Raising Capital for Businesses The Stock Exchange

a.  In the accompanying diagram (which represents the market for chocolate candy bars), the initial equilibrium is at the intersection of S1 and D1. Circle the new equilibrium if t

What are some good examples of C.O.L.A?

Cost of capital: The cost of capital is a term related to the field of financial investment to refer to the cost of a company's funds (both equity and debt), from an investor'

What are depository institutions? Depository institutions: intermediaries along with an important proportion of their funds derived through customer deposits as consists of: co

Cost of Redeemable Debentures and Preference Shares Redeemable fixed return securities have an exact maturity period.  The cost of those securities is called redemption yield