you buy a very risky bond that promises an 8.8% coupon and return of th $1,000 p

Question

you buy a very risky bond that promises an 8.8% coupon and return of th $1,000 principal in 10 years. You pay only $500 forthe bond.

A. you receive the coupon payments for two years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 2.5 years. What is the realized return on your investment?

B. The firm does far better than expected and bondholders receive all of the promised interest and principal payments. What is the realized return on your investment?

Explanation / Answer

a.   CALC:   n = 2.5x2 =5   r = ?   PV = -$500 PMT = 8.8%x1,000/2 = $44   FV = $150 - 44 = $106            r = -10.7200%

APY = (1 + r)m

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