The government is issuing a 5-year 15% bond with a face amount of 1,000,000,000. The perception in the investment community is that the government is somewhat unstable, and it is forecast that there is a 10% chance that the government will default on interest payments by the first or second years, a 20% chance of default by the third or fourth years, and a 25% chance of default (on interest and principal) by the fifth year. All probabilities are unconditional (measured from time 0, so that, for instance, the probability that the 7th coupon will be paid is .8).

(a) Find the price to be paid for this issue for an investor to earn yield P) =.18 on the expected payments.

(b) Based on the price found in part (a), find the yield to maturity if all payments are actually made.

(c) Suppose that the risk of default on the redemption amount is only 10%, but the other default risks are as stated. Repeat parts (a) and (b).

Answer rating: 100% (QA)

A Price of the coupon P 018 Face value 1000000000 Period 5years Coupon Rate 15 Default risk Year 1 Y... View the full answer