An investor has $1,200 to invest, and his financial analyst recommends two types

Question

An investor has $1,200 to invest, and his financial analyst recommends two types of junk bonds. The A bonds have a 4% annual yield with a default rate of 1%. The B bonds have aa 9% annual yield with a default rate of 5%. (If the bond defaults, the $1,200 is lost.) Which of the two bonds is better? Why? Should he select either bond? Why or why not?

Which of the two bonds is better? Why?

A. The B bonds are better because its expected value is greater than the A bonds.

B. The A bonds are better because its expected value is lower than the B bonds.

C. The A bonds are better because its expected value is greater than the B bonds.

D. The B bonds are better because its expected value is lower than the A bonds.

Should the investor select either bond?

A. He should select neither because both the A and B bonds have negative expected values.

B. He should select the B bonds because the expected value is greater than the A bonds.

C. He should select the A bonds because the expected value is greater than the B bonds.

Explanation / Answer

bond A expected value =1200*4%*0.99-1200*0.01=35.52

Bond B expected value =1200*9%*0.95-1200*0.05=42.6

A. The B bonds are better because its expected value is greater than the A bonds.

B. He should select the B bonds because the expected value is greater than the A bonds.

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