Investors are evaluating two 6-year bonds at time t in an emerging financial crisis setting where

there is a strong likelihood of default. Assume the following values for the expected probability

of default (z) of the two bonds, issued respectively by companies A and B.

t+1 t+2 t+3 t+4 t+5 t+6

A 0.1 0.2 0.3 0.3 0.4 0.3

B 0 0.2 0.6 0.7 0.3 0.25

a. Assume both bonds are 6-year, 8% coupon, $1000 face value coupon bonds, each selling for

$1000. Calculate the yields on the two bonds. Which is higher?

b. Now assume a setting where all future interest rates are exogenously fixed at 6%; the prices

of the bond are now to be determined. What are the prices of bond A and B? Which is

higher?

c. With respect to (b) above, and taking both present value streams together, does there exist

some value for i that would make the price of Bond A equal to the price of Bond B?

For each of the 3 parts, display the appropriate present value equation and give a brief one or

two-line explanation of the logic of your results. Answers should be exact and it is best to find

an appropriate program/calculation method. (b) can be done by hand and (c) can in principle be

done by trial and error, but you will find this very cumbersome. (a) cannot be done by hand.