The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics. One year rate (%) Two Year rate (%) Gov’t bond 1.50 2.25 Company bond 3.00 4.25 Spread (risk premium) 1.50 2.00 The risk manager thinks that the recovery rate on the bond is expected to be 70% in the event of default and advised that the bond should not be held for more than one year. Should the bond be purchased? Justify your decision.
The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics. One year rate (%) Two Year rate (%) Gov’t bond 1.50 2.25 Company bond 3.00 4.25 Spread (risk premium) 1.50 2.00 The risk manager thinks that the recovery rate on the bond is expected to be 70% in the event of default and advised that the bond should not be held for more than one year. Should the bond be purchased? Justify your decision.
Chapter7: Types And Costs Of Financial Capital
Section: Chapter Questions
Problem 2EP
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The investment department of your bank is analyzing the credit risks of a local bond issuer. The bank is interested in investing in the bonds over the next two years. The following table shows the expected return on the bonds and a government bond with similar characteristics.
|
One year rate (%) |
Two Year rate (%) |
Gov’t bond |
1.50 |
2.25 |
Company bond |
3.00 |
4.25 |
Spread (risk premium) |
1.50 |
2.00 |
The risk manager thinks that the recovery rate on the bond is expected to be 70% in the event of default and advised that the bond should not be held for more than one year. Should the bond be purchased? Justify your decision.
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