A Zero-Coupon Bond Has a Beta of 0

question 12

Multiple Choice

A zero-coupon bond has a beta of 0.15 and promises to pay $5,000 next year with a probability of 96%, $1,000 with a probability of 2%, and there is a 2% probability of total default. One-year Treasury securities are yielding 4%, and the expected return on the market is 10%.
-Refer to the information above. What is the default premium for this bond investment?

• A)3.9%
• B)4.8%
• C)8.8%
• D)none of the above

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Definitions:

Expected Utility Function

A mathematical representation of an individual's preference for uncertain outcomes, using probabilities to calculate the expected satisfaction or utility.

Utility Function

A mathematical representation that shows the relationship between the utility or satisfaction a consumer receives and the consumption of various goods and services.

Risk Neutral

A description of an investor or decision maker who is indifferent to risk, focusing solely on the expected outcome without regard to the variability of returns.

Income

The financial gain received by an individual or entity, usually from work, investments, business ventures, or other sources.