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A portfolio manager is considering an investment in a 4-year, 6% annual coupon payment bond corporate bond that is...

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A portfolio manager is considering an investment in a 4-year, 6% annual coupon payment bond corporate bond that is currently trading at 101 per 100 of par value. The annual conditional probability of default (hazard rate) is 5.0% and the recovery rate is 60%. The risk-free benchmark yield curve is flat at 4%. a. What is the fair value of the bond? (3 points) b. Should the portfolio manager purchase the bond? Why or why not? (1 point) c. What is the projected annual rate of return if the portfolio buys the bond at the market price of 101 per 100 of par, then the bond defaults at the end of year four? (1 point)

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a To calculate the fair value of the bond we need to discount the expected cash flows coupon payments and the final payment at maturity or recovery after default at the risk free rate The formula to calculate the fair value of a bond is Fair Value C 1 1 r n r F 1 r n Where C is the annual coupon payment View the full answer


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Financial Management Theory and Practice

Financial Management Theory and Practice

ISBN: 978-1305632295

15th edition

Authors: Eugene F. Brigham, Michael C. Ehrhardt

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Posted Date: August 31, 2023 07:15:58
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