The Ford 8.875% June 2047 bond is priced to yield 8.1% while the GE 8.875% June...

The Ford 8.875% June 2047 bond is priced to yield 8.1% while the GE 8.875% June 2047 bond is priced to yield 10.9%. The 8.875% June 2047 US Treasury bond is priced to yield 3.1%. If the market assumes that there is a 3.4% probability that Ford will default on the bond, then the default premium for the GE bond is ___ %

Expert Solution

		8.875% June 2047 Bonds

	Risk free Return (Rf) =	3.40%
	Let 'x' be default premium for GE Bond
		Ford	GE
A	Yield	8.10%	10.90%

B	Total Risk Premium	4.70%	7.50%
C	Default Premium	3.40%	x
D	Risk Premium on A/c of Investment in Market Securuties(RM)	1.30%	7.5%-x
	D=B-C

	As both 8.875% June 2047 Bonds of Ford and GE are having Same Coupon Rate and Maturity Period, there Marker Risk Premium will be Same

	Hence,
	1.30%	=	7.5%-x
	x	=	7.5%-1.3%
	Therefore, x	=	6.20%

jeff jeffy answered 3 years ago

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