Question

Consider a risky bond with maturity = 5 years, coupon = 6%, risk neutral probability of default = 4% and loss given default = 30%. Assume the risk free rate of interest is 3%, the face value of the bond is $1000, and the coupon is paid once a year. What is the fair value of the bond? What is the yield to maturity? What is the credit spread?

Answer 1

Yield to Maturity (YTM) is the speculative rate of return or interest rate of fixed-rate security, such as a bond. The YTM is based on the belief or understanding that an investor purchases the security at the current market price and holds it until the security has matured (reached its full value), and that all interest and coupon payments are made in a timely fashion.

Credit Spread = The credit spread is the difference between the yield (return) of two different debt instruments with the same maturity but different credit ratings. In other words, the spread is the difference in returns due to different credit qualities.

For example, if a 5-year Treasury bond is trading at a yield of 3% and a 5-year corporate bond is trading at a yield of 5%, the credit spread is 2% (5% – 3%).

let A bond settling on 04/15/2020 with a par value of 1,000.00, a maturity date of 04/15/2025, a coupon rate of 6% and let us consider a market yield of 3%will be priced at $326.54. (This is with a redemption value of $60.00, which is typically the same as par value.)

Well, all these factors are required to price a bond properly. The difference between the settlement date and the maturity date is the length of time for which you will be holding the bond. The longer this time period, the lower the bond's price will be. The market yield is compared to the coupon's annual rate, and the larger the difference, the lower the bond's price will be. And the redemption value is compared to par value, and the larger the difference, the lower the bond's price will be.