Question: Question 2 [10 points] Consider a 10% two year corporate bond. This bond pays a coupon of $10 at t=1 and pays back $110 at

Question 2 [10 points] Consider a 10% two year corporate bond.

Question 2 [10 points] Consider a 10% two year corporate bond. This bond pays a coupon of $10 at t=1 and pays back $110 at t=2. The default spread for an AAA rated bond is 0.25% and a BB rated bond is 9%. Suppose the risk free rate is constant at 1%. (a) Suppose the bond has an AAA rating. What is the market price of the bond at t=0? [3pl (b) Suppose the bond has a BB rating. Do investors buy the bond for $100 at t=0? (3pl Suppose the central bank changes the interest rate. Please comment on the following statements. (You can use a numerical example to illustrate your answer.) (c) The price of the AAA rated bond goes up, if the central bank increases the risk free interest rate. [2] (d) If the yield curve is not constant but increasing, the price of the BB rated bond goes up ceteris paribus. [2p]

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