You are considering buying a discount bond that costs $1,000 today and pays you $1,200 in one year.However, there is a 10 percent chance that the company issuing the bond will go bankrupt and not pay you your interest or return your principal.What is the expected return on the bond?

Question

Quizplus · Accepted Answer

To calculate the expected return, we need to take into account the probability of the company going bankrupt and not paying us back. The expected return is calculated as follows:
Expected Return = (Probability of Investment Paying Off × Return on Investment) + (Probability of Investment Not Paying Off × Loss on Investment)
Expected Return = (0.9 × (1200-1000)/1000) + (0.1 × (-1000/1000)) = 0.08 or 8%
Therefore, the expected return on the bond is 8%, which is the highest of the given options.

You Are Considering Buying a Discount Bond That Costs $1,000