Consider the case of five possible rating states, A, B, C, D, and E. A, B, and
Question:
Consider the case of five possible rating states, A, B, C, D, and E. A, B, and C are initial bond ratings, D symbolizes first-time default, and E indicates default in the previous period. Assume that the transition matrix ? is:
A 10-year bond issued today at par with an A rating is assumed to bear a coupon rate of 7%.
? If a bond is issued today at par with a B rating and with a recovery percentage of 50%, what should be its coupon rate so that its expected return will also be 7%?
? If a bond is issued today at par with a C rating and with a recovery percentage of 50%, what should be its coupon rate so that its expected return will be 7%?
1 0 0 0.06 0.90 0.03 0.01 0 II=| 0.02 0.05 0.88 0.05 0 1
Step by Step Answer:
To answer these questions we will use the formula for calculating the expected return on a bond Expected return Coupon payment Par value Market price ...View the full answer
Related Video
Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.
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