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Defaultable Bonds and Credit Default Swaps
You want to value bonds and credit default swaps of XYZ Widgets. Based on extensive historical data on comparable widget firms, you have determined the risk-neutral survival probabilities. You also observe the term structure of (annually compounded) interest rates.
Suppose that the firm issues a bond paying 6% coupons (annually) with a face value of $1000. The bond is 5 years to maturity. What is the value of this bond? Assume that there is no recovery if the bond defaults.
Suppose that the bond in (1) is hard to buy. Instead, you decide to sell protection via a 5-year credit default swap. The CDS will have annual CDS premium payments on a notional amount of $1000. Assume that there is no recovery if the bond defaults. You decide to follow the historical convention of no upfront payment. What is the required CDS premium?
If you instead want to structure the contract so that buyers of the insurance have to pay $100 upfront, what CDS premium could you charge?
The highest risk bond to an investor, looking at the bonds issued by one company, are ___ bonds. After a bond is sold, the going rate of interest increases. This will have the effect of ___ the present value of remaining interest payments, and _____ ..
A regional soft drink manufacturer is considering opening a new manufacturing plant in the Midwest. Its total fixed costs are $100 million, with the cost of the new plant included in that figure at a depreciated value based on the expected life of th..
Stock in CDB Industries has a beta of .95. The market risk premium is 7 percent, and T-bills are currently yielding 4 percent. CDB’s most recent dividend was $2.40 per share, and dividends are expected to grow at an annual rate of 5 percent indefinit..
Over the last 5 years, the Russell small stock index has consistently out-performed the Russell large stock index. The S&P400 index is composed of the 400 largest stocks in the S&P500. The yield curve almost always slopes upward. An asset that last y..
Melanie receives an annuity paying $1,000 at the end of each month for eight years. This is directly deposited to a fund paying interest at an annual effective rate of 7.28%. Interest is paid out at the end of each year to a fund with an annual yield..
Long-term revenue forecasts:
Refer to the search you performed in the Learning Activities on the U.S. Securities and Exchange Commission's (SEC) website. This search should have produced a variety of financial documents for the publically traded companies you searched. Identify ..
Three years ago, James Matheson bought 340 shares of a mutual fund for $23 a share. During the three-year period, he received total income dividends of 0.68 per share. He also received total capital gain distributions of $1.65 per share. At the end o..
An investor in the 28 percent tax bracket is trying to decide which of the two bonds to purchase. One is corporate bond carrying an 8 percent coupon and selling at par. The other is a municipal bond with a 5 ½ percent coupon and it, too, sells at par..
The fair rate of return on similar debentures is 14% before tax. Calculate the present value of the capital portion of the debenture.
In October 2012, the average house price in the United States was $221,300. In October 2004, the average price was 286,300. What was the annual change in the average selling price?
Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over six years using the straight-line method. What is the maximum price that the company should be willin..
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