The bond capacity (Face Value) is $100,000 The bond is issued for 5 years Regardless of when the contractor reneges on the successful completion of the job, the draw down on the bind only takes place at the end of the year. The term structure of spot rates of interest at the time of surety issue is the following:

Year	ROI(%)
1	3.91
2	4.45
3	4.81
4	5.01
5	6.00

The probabilities and exposure (percent of capacity) of the surety company year-wise is as follow:

Year	Prob(%)	Exposure(%)
1	20	20
2	20	10
3	20	5
4	20	3
5	20	5

Compute the fair price of the surety bond.

Answer rating: 100% (QA)

To compute the fair price of the surety bond we can use the concept of the fair value of a bond as t... View the full answer