A bond subject to default is equivalent to
A)a payer swaption
B)a call and a default-free bond
C)a put and a call
D)a default-free bond and a short put
E)none of the above

Question

Quizplus · Accepted Answer

A bond subject to default can be replicated by buying a default-free bond and selling a short put option. If the bond defaults, the investor will lose the amount invested in the bond, but will have received the premium from selling the put option, which can offset the losses.

A Bond Subject to Default Is Equivalent to