A bond has an expected yield-to-maturity of 8% and a 10% probability of default. If the bond defaults, the bondholder should receive 80% of the market value. The bond would be fairly priced if its default premium were
A) 2.4%.
B) 6.2%.
C) 3.1%
D) 5.4%.

Question

Quizplus · Accepted Answer

To determine the fair price of a bond, one needs to consider the default risk premium, which represents the additional return that investors require to compensate for the risk of default. If the default premium is too high, the bond may be overvalued. If it is too low, the bond may be undervalued. The best choice is C) 3.1%, as it represents a reasonable premium for a bond with average credit risk. Choices A, B, and D either represent too high or too low default premiums, which would result in an overpriced or underpriced bond.

A Bond Has an Expected Yield-To-Maturity of 8% and a 10