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A zero-coupon bond has a beta of 0.3 and promises to pay $1000 next year with...

A zero-coupon bond has a beta of 0.3 and promises to pay $1000 next year with a probability of 95%. If the bond defaults, it will pay nothing. One -year Treasury securities are yielding 2%, and the equity premium is 5%. What is the fair market value for this bond investment? $918 $950 $1,000 $956

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Answer #1

Required rate of return = Risk free rate+ [Equity premium * beta]

                      = 2+ [5*.3]

                     = 2+ 1.5

                    = 3.5%

Probability Future payment in one year Expected payment in year 1
.95 1000 1000*.95 = 950
.05 0 0
950

Value of bond today = PVF 3.5%,1*Value in one year

          = .96618*950

         = $ 917.87    (rounded to 918)

correct option is "A" -

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