question archive Suppose that the interest rate on a one-year risk-free bonds is 5%, and now a corporate bond is issued with a face value of €1,000, maturing in 1—year
Suppose that the interest rate on a one-year risk-free bonds is 5%, and now a corporate bond is issued with a face value of €1,000, maturing in 1—year
Subject:FinancePrice: Bought3
Suppose that the interest rate on a one-year risk-free bonds is 5%, and now a corporate bond is issued with a face value of €1,000, maturing in 1—year. The payoff in the case that the company doesn't default is €1050 with probability 80%, and 20% for the default case where bond holders receive nothing. With this chance in default, investors demand a 3% risk premium, which can be seen priced into the market.
(a) What is the price ofthe bond, and what is its promised yield?
(b) What is a recovery rate and how will the price ofthe bond change with a recovery rate of 40%
(c) You are worried about the risk of default on your bond investments. Do you buy or sell credit default swaps?
