EBK INVESTMENTS
11th Edition
ISBN: 9781259357480
Author: Bodie
Publisher: MCGRAW HILL BOOK COMPANY
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Question
Chapter 15, Problem 5CP
Summary Introduction
To calculate: Based on the information provided, recommend either Bond A or Bond B for purchase.
Introduction: Bonds are debt instruments that are issued by the governments or corporate for the purpose of raising money from the market, under a particular agreement. For all those who subscribe to the bonds, the issuer has to pay the interest based on the coupon rate of the bond.
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The tables below show, respectively, the characteristics of two annual-pay bonds from the same issuer with the same priority in the event of default, and spot interest rates. Neither bond’s price is consistent with the spot rates. Using the information in these tables, recommend either bond A or bond B for purchase. Bond Characteristics
Bond A Bond B
Coupons Annual Annual
Maturity 3 years 3 years
Coupon rate 10% 6% Yield to maturity 10.65% 10.75%
Price 98.40 88.34 Spot Interest Rates
Term (Years) Spot Rates (Zero-Coupon)
1 5%
2 8
3…
Consider an A-rated bond and a B-rated bond. Assume that the one-year probabilities of default for the A- and B-rated bonds are 1% and 3%, respectively, and that default correlation between the two bonds is 20%. What is the joint probability of default of the two bonds?
You are given the following details of three default free government bonds. Assume that one can take long (buy) and short (sell) positions in these bonds. CF stands for cash flow.
Bond
Current price Today
CF Year 1
CF Year 2
A
95.24
100
0
B
89.85
0
100
C
X
70
1070
Assuming that the current market prices of Bond A and Bond B are correct, then, what should be the current theoretical (fundamental) price of Bond C, as per the no-arbitrage principle, i.e., what is the value of X?
[Do not round-off any numbers. If at all you want to round-off a number, round it off at 8 decimal places.]
Chapter 15 Solutions
EBK INVESTMENTS
Ch. 15 - Prob. 1PSCh. 15 - Prob. 2PSCh. 15 - Prob. 3PSCh. 15 - Prob. 4PSCh. 15 - Prob. 5PSCh. 15 - Prob. 6PSCh. 15 - Prob. 7PSCh. 15 - Prob. 8PSCh. 15 - Prob. 9PSCh. 15 - Prob. 10PS
Ch. 15 - Prob. 11PSCh. 15 - Prob. 12PSCh. 15 - Prob. 13PSCh. 15 - Prob. 14PSCh. 15 - Prob. 15PSCh. 15 - Prob. 16PSCh. 15 - Prob. 17PSCh. 15 - Prob. 18PSCh. 15 - Prob. 19PSCh. 15 - Prob. 1CPCh. 15 - Prob. 2CPCh. 15 - Prob. 3CPCh. 15 - Prob. 4CPCh. 15 - Prob. 5CPCh. 15 - Prob. 6CPCh. 15 - Prob. 7CPCh. 15 - Prob. 8CPCh. 15 - Prob. 9CPCh. 15 - Prob. 10CP
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