Consider a one year bond at 750 wth a coupon of 8 what is th

Consider a one year bond at $750 wth a coupon of 8% what is the yield to maturty? Suppose there\'s a 40% probabity of default and rthe event of a defaut tere would be a 7S% recovery rate. Suppose in the event of a default the company would pay zero interest back What is the espected return on the bond?

Solution

Soln: Step 1: Let r be the yield to maturity of the bond , Bond price : $750 , maurity , t = 1 year, coupon = 8%.

As coupon payment schedule not given, we consider it annual.

we can say that , Price of the bond = (Coupon + Face value)/(1+r)^t = (80+1000)/(1+r)

1+r = 1080/750 = 1.44 and r = 0.44 , or we can say that YTM = 44% of this bond.

Step 2: Again for this bond the PD = 40% and recovery rate = 75%

In the event of default the expected return,1+ R = (60%*1080 + 40%*75%*1000)/750

R = 26.40%