An investor is considering between purchasing a Treasury Bond and a bond from a large...
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An investor is considering between purchasing a Treasury Bond and a bond from a large corporation. Both bonds have a face value of $1,000. The Treasury Bond has no risk, while the corporate bond has a 10% change of not repaying (a default). Both bonds are 2-year bonds and dont pay any coupons, only the final payment at maturity.
a) Assuming that the interest rate in year 1 is 10% and in year 2 is expected to be 5%, what is the current price of each bond? Why are the values different?
b) Now assume that the investor purchased the Treasury Bond a year has passed. How much can this bond be sold for if the interest rate is confirmed at 5%?
c) Continue assuming that the investor purchased the Treasury Bond a year has passed. If the investor is offered the corporate bond for $800, should it be purchased? Explain.
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