Question

In: Finance

Consider a zero-coupon bond maturing in 2 years with a face value of $1,000 and a...

Consider a zero-coupon bond maturing in 2 years with a face value of $1,000 and a yield to maturity of 2%. Assume the recovery rate is 40%, and that default can only happen exactly at the end of the 2-year period. There is a credit default swap (CDS) available for this bond, and the premium is 0.8%.

For both a bondholder and a CDS buyer (with notional value $1,000), compute the cash flows two years from today in the case where the bond defaults and the case where it doesn’t. Include only cash flows two years from today, and not the quarterly payments the CDS buyer makes to the CDS seller or the up-front cost of the bond.

Scenario	Bond cash flow	CDS cash flow
Default
No Default

Now consider a portfolio consisting of a bond with face value $1,000 and a CDS with notional value $1,000. Compute the cash flows two years from today in the case the bond defaults, and in the case it doesn’t. Include only cash flows two years from today, and not the quarterly payments the CDS buyer makes to the CDS seller or the up-front cost of the bond.

Scenario	Portfolio cash flow
Default
No Default

Expert Solution

A. Scenerio 1 - In case of Default

Cash Flow for Bond Holder = Notional Amount * Recovery Rate

= 1000 * 40% = $400 (Inflow)

Cash flow for CDS Buyer = Notional Amount * (1- Recovery Rate)

= 1000 * (1-40%) = $600 (Inflow)

As per CDS Agreement, CDS buyer pays premium to CDS Seller ans in case of default , CDS seller makes on time payment to CDS Buyer of amount defaulted by reference Entity (i.e here Bond Issuer)

Scenerio 2 = In case of no Default

Cash Flow for Bond Holder = Notional Amount

= $1000 received as there is no default

Cash flow for CDS Buyer = 0 as there is no default , CDS seller is not liable to pay anything to CDS Buyer.

B. Portfolio Cash flows

In case of default = $400+ $600 = $1000

In case of no default = $1000 +0 = $1000

(Remember Bond is backed by CDS, CDS in the portfolio only has value if default occurs.

Also there is no need to do Weighted Average as both represents same asset, it is just that CDS is security here)

jeff jeffy answered 2 years ago

Suppose you purchase a zero coupon bond with face value $1,000, maturing in 27 years, for...

Suppose you purchase a zero coupon bond with face value $1,000, maturing in 27 years, for $693.33. What is the implicit interest, in dollars, in the first year of the bond's life?

Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 19...

Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 19 years, for $215.75. Zero coupon bonds pay the face value on the maturity date.Whatis the implicit interest in the first year of the bond's life?

Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 18...

Suppose you purchase a zero coupon bond with a face value of $1,000, maturing in 18 years, for $214.70. Zero coupon bonds pay the investor the face value on the maturity date. What is the implicit interest in the first year of the bond’s life?

2) There is a 7% coupon bond (semiannual) maturing in 2 years. A face value is...

2) There is a 7% coupon bond (semiannual) maturing in 2 years. A face value is $1,000. Then the price of the bond is $ . (Note:Round to the nearest hundredth.) 1) What are the 1.5 year and 2 year forward rates? (Note: Round to the nearest hundredth.) Maturity (Year) Spot Rate Forward Rate 0.5 3.01 % 3.01% 1 3.21 % 3.41% 1.5 3.53 % % 2 3.87 % %

Consider two Bonds: 1) a zero-coupon bond with face value F maturing in 1 year; 2)...

Consider two Bonds: 1) a zero-coupon bond with face value F maturing in 1 year; 2) a coupon bond with face value F maturing in 4 years, i.e., T = 4, with coupon of $12 paid annually. Suppose that the continuous compounding is at the rate of r = 10%. (4a). If the price of bond 2 is equal to 1.15 times that of bond 1, find the face value F. (4b). If F = $100, how long will it...

A zero coupon bond with a face value of $1,000 that matures in 8 years sells...

A zero coupon bond with a face value of $1,000 that matures in 8 years sells today for $556. What is the yield to maturity? (Use annual compounding.)

Consider a zero-coupon bond with a $100 face value maturing in 5 years. What is the yield to maturity of this bond if it is currently trading at $72?

a. Consider a zero-coupon bond with a $100 face value maturing in 5 years. What is the yield to maturity of this bond if it is currently trading at $72? Answer in percent, rounded to one decimal place.b. What is the value of a ten-year 6% annual coupon bond with face value of $1,000, assuming yield-to-maturity of 5%. Round to the nearest cent.c. What is the value of a 20-year 4% coupon bond withsemi-annual coupons, $1,000 face value, and a...

A zero-coupon bond with face value $1,000 and maturity of four years sells for $737.22. a....

A zero-coupon bond with face value $1,000 and maturity of four years sells for $737.22. a. What is its yield to maturity? (Round your answer to 2 decimal places.) b. What will the yield to maturity be if the price falls to $721?

A zero-coupon bond with face value $1,000 and maturity of four years sells for $753.22. a....

A zero-coupon bond with face value $1,000 and maturity of four years sells for $753.22. a. What is its yield to maturity? (Round your answer to 2 decimal places.) Yield to maturity % b. What will the yield to maturity be if the price falls to $737? (Round your answer to 2 decimal places.) Yield to maturity %

A zero-coupon bond with face value $1,000 and maturity of four years sells for $756.22. a....

A zero-coupon bond with face value $1,000 and maturity of four years sells for $756.22. a. What is its yield to maturity? (Round your answer to 2 decimal places.) Yield to maturity % b. What will the yield to maturity be if the price falls to $740? (Round your answer to 2 decimal places.) Yield to maturity %