Three-year T-Notes with a coupon of 10% are trading for $951.96 to yield 12%.(With a $1,000 face value.)Microsoft has just issued a three year bond with a 10% coupon and a face value of $1,000.Analysts estimate that the default risk premium on Microsoft bonds is 3% and the liquidity risk premium is the same as the T-Note.What is the fair price for the Microsoft bond today?

Question

Quizplus · Accepted Answer

Since the Microsoft bond has the same maturity and liquidity risk as the T-Note, the only difference in the yield is the default risk premium of 3%. Thus, the yield on the Microsoft bond is 12% + 3% = 15%. P_bond = C × 11ea7fdb_fbff_eba6_a768_83ce83857d0b_TB2902_11 + 11ea7fdb_fbff_eba7_a768_cd0b1168b79a_TB2902_11 P_bond = $100 × 11ea7fdb_fbff_eba8_a768_6f43de65be7b_TB2902_11 + 11ea7fdb_fbff_eba9_a768_955fd37e1156_TB2902_11 = $885.84 Using a financial calculator: N = 3, I/Y = 15 PMT = 100, FV =1,000 CPT PV = $885.84

Three-Year T-Notes with a Coupon of 10% Are Trading for $951.96