Question

Suppose the current 1-year US treasury rate is 3.00%. A. Calculate the yield for a $100...

Suppose the current 1-year US treasury rate is 3.00%.
A. Calculate the yield for a $100 face value 1-year corporate bond with a 3% coupon and a 2.5% probability of default.
B. What is the risk premium, if any, for this bond?

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Answer #1

Answer: We will have to calculate the expected yield in this scenario as there are two probabilities.

one with 0.975 chances of getting the coupon value of $3 and other with 0.025 with no coupon amount

Expected yield = 0.975 * $3 + 0.025 * 0

Expected yield in % = 2.925 /100 = 2.925%

Answer B : Risk Premium = Market return - risk free return

Market return here is Expected return yield for the bond

Risk premium = 2.925 - 3%

Risk premium is in negative here = -0.075%

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