Problem 2

Continuing with the above example, if the trader buys the bond at 105.500, what are the potential projected annual rates of return? (In other words, what are the returns if the bond defaults after 1 to 3 years, and if the bond pays in full for the full 3 years.)

Note: If you cannot calculate the recovery amounts in the final year, assume the following recoveries for the final year:

• 19 for the bond that defaults after year 1
• 20 for the bond that defaults after year 2
• 21 for the bond that defaults after year 3

\begin{tabular}{|c|c|} \hline Default & IRR \\ \hline 1 & \\ \hline 2 & \\ \hline 3 & \\ \hline No default & \\ \hline \end{tabular} \begin{tabular}{|c|c|} \hline Default & IRR \\ \hline 1 & \\ \hline 2 & \\ \hline 3 & \\ \hline No default & \\ \hline \end{tabular}