Question 2: The current term structure is shown here:

1. (7 marks) Calculate the current price of a government bond with a face value of $1000 and a coupon rate of 7%. It is an annual coupon bond that matures in 3 years.
2. (13 marks) Calculate the current price of a bond issued by XYZ corporation if it has a face value of $1000 and a coupon rate of 7%. It matures in 3 years. Use the following table to find the default risk premium. (Assume the default risk is not a function of maturity)

The Term Structure of Interest Rate Chart Area 6 Interest rate (%) 1 0 0 1 4 5 2 3 Time to maturity (year) Bond Rating Required rate of interest AA ? B 8.5% AA 7.2% XYZ Co. 7% 3 years from now ABC Co. 8% 3 years from now NP Co. 10% 5 years from now XT Co. 3% 5 years from now BB Co. 10% 3 years from now AA 7.7% A 6.85%