Consider an economy with three types of bonds. All three bonds have the same characteristics, except...

 

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Consider an economy with three types of bonds. All three bonds have the same characteristics, except for the identity of the issuer. Bond A is issued by the U.S. treasury and pays a nominal interest rate of i4 = 3%. Bond B is issued by a solid company listed in the S&P 500 index and pays a nominal interest rate ig = 5%. Bond C is issued by a small company struggling to survive amidst the effects of the Coronavirus pandemic. The market thinks bond C has a probability of default of pc = 20%. 1. Compute bond B's risk premium, TB, and its probability of default, PB. 2. Compute bond C's risk premium, xc, and the rate of return it offers to investors, ic. 3. You are an investor interested in maximizing the expected return of buying bonds. Which bond would you choose to buy and why? Consider an economy with three types of bonds. All three bonds have the same characteristics, except for the identity of the issuer. Bond A is issued by the U.S. treasury and pays a nominal interest rate of i4 = 3%. Bond B is issued by a solid company listed in the S&P 500 index and pays a nominal interest rate ig = 5%. Bond C is issued by a small company struggling to survive amidst the effects of the Coronavirus pandemic. The market thinks bond C has a probability of default of pc = 20%. 1. Compute bond B's risk premium, TB, and its probability of default, PB. 2. Compute bond C's risk premium, xc, and the rate of return it offers to investors, ic. 3. You are an investor interested in maximizing the expected return of buying bonds. Which bond would you choose to buy and why?

Answer rating: 100% (QA)

The riskfree rate offered by the US treasury is around 285 hence the risk premium on ... View the full answer