Star Light & Power has junk bonds with an 8% coupon rate, 20 years to maturity, and pays semi-annual coupons. You purchase the junk bonds at the market price of 82.50% of par.

Suppose that you believe that Star Light & Power’s junk bonds will receive a ratings upgrade to investment grade due to increasing financial strength in Star Light & Power’s balance sheet. If the average investment grade bond has a yield to maturity of 5% and Star Light & Power’s does receive the ratings upgrade, what is your expected profit?

Answer rating: 100% (QA)

To calculate the expected profit from the bond investment given the potential ratings upgrade we need to consider the difference in yield to maturity ... View the full answer