B18. (Default risk) You buy a veryrisky bond that promises a 9.5% coupon and ret
ID: 2662289 • Letter: B
Question
B18. (Default risk) You buy a veryrisky bond that promises a 9.5% coupon and return ofthe
$1,000 principal in 10 years. You payonly $500 for the bond.
a. You receive the coupon payments forthree years and the bond defaults. Afterliquidating
the firm, the bondholders receive adistribution of $150 per bond at the end of 3.5
years. What is the realized return onyour investment?
b. The firm does far better thanexpected and bondholders receive all of thepromised
interest and principal payments. What is therealized return on your investment?
Explanation / Answer
$500.00
$1,000
9.50%
3.5 years
3.5
-95
500.00
-1,000
Realized Rate of Return onInvestment (Rate)
0.3734
37.34%
10
-95
500.00
-1,000
0.2242
22.42%
(a)Calculating Realized Return onInvestment (Rate): Present Value of theBond$500.00
Par Value of theBond$1,000
Annual Coupon Rate9.50%
Number of Years toMaturity3.5 years
Calculating Realized Return on Investment(Rate): (Using Ms-Excel "RATE"Function): Number of years toMaturity3.5
Annual Coupon Payment (PMT) ($1000 *9.50%)-95
Present Value of the Bond(PV)500.00
Future Value (or) Parvalue of theBond (FV)-1,000
Realized Rate of Return onInvestment (Rate)
0.3734
Realized Return onInvestment (Rate)37.34%
(b)Calculating Realized Return onInvestment (Rate): Present Value of theBond $500.00 Par Value of theBond $1,000 Annual Coupon Rate 9.50% Number of Years toMaturity 10 years Calculating Realized Returnon Investment (Rate): (Using Ms-Excel "RATE"Function): Number of years toMaturity10
Annual Coupon Payment (PMT) ($1000 *9.50%)-95
Present Value of the Bond(PV)500.00
Future Value (or) Parvalue of theBond (FV)-1,000
Realized Rate of Return onInvestment (Rate)0.2242
Realized Return onInvestment (Rate)22.42%
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