There are two one-year discount bonds issued by two corporations, Corporation A and Corporation B. They are both offering a face value of F = $1,716. One of the two corporations is quit risky, the other not so much. Corporation A is asking $1,560 for its bond while corporation B is asking for $1,320. Suppose that these are the true values of the bonds under perfect information about the riskiness of the corporations. 

You are thinking of lending to one of these two corporations by buying its bonds. However, you cannot tell the difference between these two corporations and think that with 50% probability either one could be risky. As a result you are willing to pay X dollars for either bond. On the basis of this price, I conclude that you are willing to charge an interest rate of Y percent for your loan to either corporation.

What are the values of X and Y?

Answer rating: 100% (QA)

Since the investor believes there is a 50 chance that either corporati... View the full answer