Suppose you have been hired as a financial consultant, and your job is to price

Question

Suppose you have been hired as a financial consultant, and your job is to price two bonds, A and B. The bonds are identical in every way (e.g. they have the same coupon payment, maturity data, etc.), except that A is “riskier” than B – i.e. you think the probability of full payment of principal and interest is lower for A than it is for B. Ceteris paribus, it follows that the discount rate you employ for pricing bond A will be ____ than that of bond B, and the price of bond A will be _____ than that of bond B.
(a) greater; less
(b) less; less
(c) less; greater
(d) greater; greater

Explanation / Answer

(d) greater; greater Risky bonds are considered risky as we feel that the full payment of principle and intrest is low. But the yeild of these bonds are expected to be higher than the risk free bonds, so we discount them with a higher rate, and they are also priced higher than the risk free bonds.

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