A zero-coupon bond has a beta of 0.1 and promises to pay $1,000 next year with a probability of 98%. If the bond defaults, it will pay nothing. One-year Treasury securities are yielding 5%, and the equity premium is 7%.
-Refer to the information above. What is the fair market value of the bond?
A)$927.15
B)$980.00
C)$946.07
D)$950.57

Question

Quizplus · Accepted Answer

The fair market value of the bond is the present value of the expected cash flow. The expected cash flow is $980 (98% * $1,000). The discount rate is the risk-free rate plus the equity premium, which is 12% (5% + 7%). The present value of the expected cash flow is $927.15 ($980 / 1.12).

A Zero-Coupon Bond Has a Beta of 0