Suppose that the possibility of default on a firm's bond is totally unrelated to other events in the economy. In this case, the beta of the bond will equal zero and the discount rate will equal the risk-free rate.

Question

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If a bond's default risk is unrelated to the economy, it implies no systematic risk, resulting in a beta of zero. Consequently, the bond's discount rate would be the risk-free rate, as it only compensates for time value of money, not risk.

Suppose That the Possibility of Default on a Firm's Bond