Question

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

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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