Problem: (Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the $1,000 principal in 10 years. You pay only $500 for the bond.
A) You receive the coupon payments for three years and the bond defaults. After liquidating the firm, the bondholders receive a distribution of $150 per bond at the end of 3.5 years. What is the realized return on your investment?
B) The firm does far better than expected and bondholders receive all of the promised interest and principal payments. What is the realized return on your investment?
| Face |
1000 |
| Coupon Rate |
9.50% |
| Years to maturity |
10 |
| Years |
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| 1 |
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| 2 |
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| 3 |
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| 4 |
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| 5 |
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| 6 |
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| 10 |
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