I calculated expected return for the two scenarios individually and then added them. I end up getting a negative answer in that case. Is it absolutely absolutely necessary to calc the payoff first and then determine the return. Can’t we calc return separately for the two scenarios and then multiply by their their probability to obtain the return on the bond? What’s wrong with that approach? Thanks!
Maybe you should write the question, not everybody uses prep providers.
There’s nothing wrong with your approach; I submit that you’ve fouled up your arithmetic somewhere.
The return if the bond defaults is $600/$950 – 1 = -36.84%.
The return if the bond doesn’t default is $1,080/$950 – 1 = 13.68%.
The expected return is 0.1(-36.84%) + 0.9(13.68%) = 8.63%, which is the answer they got: ((0.1($600) + 0.9($1,080))/$950 – 1 = $1,032/$950 – 1 = 8.63%.
What a blunder! I rechecked the calculations. Thank you so much.
My pleasure.
(If you have to make blunders, now’s the time to do it. Get them out of your system before the real exam.)
Yes. I am trying to do so. Though I am not keeping up if I comparr my prep to others on this forum and my friends, but I believe I should be just fine before the exam. Only the mocks will tell me that. Gotta go, do some number crunching 