A Risky Bond Promises to Pay $4,000 at the End

question 3

Multiple Choice

A risky bond promises to pay $4,000 at the end of three years. The bond has a risk neutral probability of default of 20%. If in default, the bondʹs residual payout will be $3,200. If the risk free rate is 6%, what is likely price of the bond today?

• A) $ 3,108
• B) $ 3,207
• C) $ 3,358
• D) $ 4,000

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Definitions:

Purchasing Power

The ability of a currency to acquire goods and services, often considered in the context of inflation affecting this ability.

Flow of Funds

The movement of money between different sectors of an economy, illustrating how funds are distributed and used.

Derivative Securities

Instruments in financial markets that derive their value from an underlying asset, index or financial benchmark, designed for risk management and speculative purposes.

Nikkei Stock Index

A stock market index for the Tokyo Stock Exchange, representing the performance of leading companies in Japan.