A corporate bond matures in one year.The bond promises a coupon of $50 and principal of $1,000 at maturity.If the bond has a 10% probability of default and payment under default is $400,calculate the expected payment from the bond.

Question

Quizplus · Accepted Answer

To calculate the expected payment, we need to multiply the probability of default by the payment under default and subtract that from the expected payment under no default.

Expected payment under no default = Coupon payment + Principal payment = $50 + $1,000 = $1,050

Expected payment under default = Probability of default x Payment under default = 0.10 x $400 = $40

Expected payment = Expected payment under no default - Expected payment under default = $1,050 - $40 = $1,010

Therefore, the expected payment from the bond is $985 (Option C).

A Corporate Bond Matures in One Year