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It is the heart of the financial crisis and Lehman brothers is trying to raise money....

It is the heart of the financial crisis and Lehman brothers is trying to raise money. They issue a zero-coupon bond with a face value of $1000 and a term of 1 year. However, you expect that Lehman will go bankrupt with probability 75%, in which case you get $0 in one year rather than the full $1000. Only with probability 25% do you receive the full $1000. If Lehman has an opportunity cost of capital of 20%, how much are you willing to pay for the bond? What is the yield-to-maturity of the bond?

A- $208.33 ; 380%

B- $833.33 ; 20%

C- $833.33 ; 380%

D- $208.33 ; 20%

Solutions

Expert Solution

Amount received in future =75%*0+25%*1000 =250

Amount willing to pay for the bond =250/(1+20%)=208.33
YTM for the bond =(Face Value/Price)^(1/n)-1 =(1000/208.33)^(1/1)-1 =380%

Option A is correct option $208.33 ; 380%

jeff jeffy answered 2 years ago
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