ONLY NEED HELP WITH D, E AND F. Answers to parts A-C are here for reference. Ima
ID: 2759130 • Letter: O
Question
ONLY NEED HELP WITH D, E AND F. Answers to parts A-C are here for reference.
Imagine a discount bond that promises to pay you $1000 a year from now. Suppose the market interest rate is 5%.
a. If there is no default risk, what is the appropriate price (PDV) of that bond? 952.38
b. If the default risk is 10%, what is the expected PDV of that bond? (This requires two calculations, one of expected value and one of PDV. The order does not matter.) 909.09
c. Explain why a risk-neutral person would not be willing to buy the bond for the dollar amount in (a.). risk neutral investor will not buy the bond at price mentioned in a because this bond will offer return for equal to market rate of interest only for decline in the value of currency if interest rates fall returns will be low.
d. Explain why a risk-neutral person would be willing to buy the bond for the dollar amount in (b.).
e. Explain why a risk-averse person might be willing to buy the bond, but only for a lower price than that.
f. Suppose that the going price for this bond is $800.
i. What is the interest rate on this bond (if it does not default)? ii. What is the expected return on this bond? iii. What is the risk premium on this bond, if the interest rate on a one-year Treasury bond is 5%?
Explanation / Answer
d)He will be willing to buy bond if he expects the market interest rate is going to increase going forward in one yearhigher than default risk and he can sell the bond and higher price
e)He will be buying at lower oprice tthan taht because the default risk is higher than the market interest rate and also because of curency issues thee price may come down furhter
f)use rate formuale to find it
=RATE(1,,-800,1000,0,)=25%
Risk premium=25%-5%=20%
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