A risky bond promises to pay $4,000 at the end of three years. The bond has a risk neutral probability of default of 20%. If in default, the bondʹs residual payout will be $3,200. If the risk free rate is 6%, what is likely price of the bond today?
A) $ 3,108
B) $ 3,207
C) $ 3,358
D) $ 4,000

Question

Quizplus · Accepted Answer

The expected payout is calculated as (0.8 * $4,000) + (0.2 * $3,200) = $3,840. The present value of this expected payout is $3,840 / (1 + 0.06)^3 = $3,207.

A Risky Bond Promises to Pay $4,000 at the End