Question

Bonds and Probability

Consider a 6-year 5.5% coupon bond that is rated BBB when issued at par (i.e.,
$1,000) at the beginning of this year. Assume that the recovery rate is 46% of the
face value in the case of default.
Rating one year later Probability Yield
AAA 0.03 4.43
AA 0.21 4.56
A 4.56 4.8
BBB 89.38 5.5
BB 4.82 9.45
B 0.68 11.7
CCC 0.24 15.15
Default 0.08 —
(a) Plot the probability distribution of the bond value one year later, where the
first-year coupon is not included. What do you find?
(b) What is the expected value of the bond one year later?
(c) If you plan to hold this bond for one year, what is the VAR in dollar terms at
the 99% confidence level?

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