Question

A one-year U.S. Treasury discount bond has a face value of $52,500.00 and is selling for $50,000.00 today. A corporation bond has a face value of $45,000.00. The corporation bond is quite risky and carries a risk premium of 20% over the Treasury bond. So, the price of the corporation bond in the market should be dollars.

Answer 1

First we need to find the ytm of the treasury discount bond and then we can find the price of the corporation bond. We assume that both bonds have no payments in between. And the maturity for both the bonds is 1 year

FV of treasury bond = 52,500

PV of treasury bond = 50,000

N = 1

PMT= 0

We will divide the return on the bond by the initial investment to find the yield of the treasury bond.

Return on the bond = (52,500-50,000)/50,000

=2,500/50,000= 0.05

=5%

The yield on the treasury bond is 5%

So the yield on the corporation bond will be 25% as it has a 20% risk premium so (20+5)= 25

In order to find the price of the Corporation bond we will divide 45,000 by 1.25, because we need a 25% return on the bond so the price of the bond will be a price, at which a 45,000 Fv is a 25 % return

45,000/1.25= 36,000

The price of the corporation bond will be $36,000

Step-by-step explanation: