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question 23

Essay

There is a 0.5% probability of default by the year-end on a one-year bond issued at par by a particular corporation. If the corporation defaults, the investor will not get anything. Assuming that a default-free bond exists with identical cash flows and liquidity, and the one-year yield on this bond is 4%.
a. What yield should be required by risk-neutral investors on the corporate bond?
b. What should the credit spread be?

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Definitions:

Entity-wide Disclosures

Refers to the disclosure of financial information by a business entity that pertains to its operations, financial condition, and performance, taking into account all divisions and geographic locations.

IFRS 8

A segment of International Financial Reporting Standards related to Operating Segments, requiring certain entities to disclose information about their operating segments, products and services, geographical areas, and major customers.

Impairment Loss

A reduction in the recoverable amount of a fixed asset or goodwill below its carrying amount, recognized in the financial statements.

Net Realizable Value

The estimated selling price of goods, minus estimated costs of completion and any costs necessary to make the sale.