Question

A bond has an expected yield-to-maturity of 6% and an 10% probability of default. If the bond defaults, the bondholders should receive 80% of the market value. If fairly priced, the bond should have a promised yield-to-maturity of A. Show the Formula (0.2 point) B. Show the Steps (0.2 point) C. Present the Answers ( 0.1 point)

Answer 1

A. The formula is:

Promised yield-to-maturity = Expected yield-to-maturity + Probability of default * (1 - Recovery rate)

B. The steps are:

1. Plug in the values into the formula:
Promised yield-to-maturity = 6% + 10% * (1 - 80%)
2. Simplify the expression:
Promised yield-to-maturity = 6% + 10% * 0.2
Promised yield-to-maturity = 6% + 2%
3. Calculate the final answer:
Promised yield-to-maturity = 8%

C. The promised yield-to-maturity of the bond should be 8%.