Problem
Investors are evaluating two 6-year, 6% coupon bonds at time t issued in a financial crisis setting where there is a strong likelihood of default. Assume the following values over time for the probability of default (z) of the two bonds, issued respectively by companies A and B
t+1 t+2 t+3 t+4 t+5 t+6
A 0.1 0.6 0.5 0.5 0.3 0.25
B 0 0.1 0.2 0.4 0.3 0.3
Assume both bonds are, $1000 face value coupon bonds, each of which has been bought at $1000. Calculate the yields on the two bonds. Which is higher?