A corporate bond matures in one year. The bond promises a $50 coupon and a principal payment of $1,000 at maturity.
If the bond has a 15% probability of default and payment under default is $400, calculate the expected payment from the bond.

Question

Quizplus · Accepted Answer

The expected payment is the sum of the probability-weighted outcomes. 
The probability-weighted outcome for non-default is: 
$50 (coupon) + $1,000 (principal) = $1,050 
The probability-weighted outcome for default is: 
$400 (payment under default) + $0 (nonpayment of coupon and principal) = $400 
The expected payment is: 
(0.15)($400) + (0.85)($1,050) = $60 + $892.50 = $952.50 
Therefore, the correct answer is C.

A Corporate Bond Matures in One Year