Ross, westerfield, and Jordan (RWJ), Fundamentals of Corporate Finance 2024 release
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The Uris & Warren Ralings Agency rates bonds on a simplified scale with just three categories: A, B, and C. The Professors Pension Fund has all its money invested in two bonds, X and Y, both of which are currently rated B. Over the course of the next year, the ratings of the bonds may change; the end-of-year value (in millions) of each bond depends on its end-of-year ratings as in the following table: Value 100 Value 100 The joint distribution of the end-of-year ratings of the two bonds is given by the following table: 0.06 0.12 0.12 0.10 0.20 0.20 0.04 0.08 0.08 A. What is the probability that bond X will be rated C at the end of one year? What is the probability that bond Y will be rated C at the end of one year? B. Find the expected value of the year-end value for each bond. C. The pension fund buys an insurance contract that will pay 20 million if either bond is downgraded to C. If both bonds are downgraded, the contract still pays 20; if neither is downgraded, the contract pays nothing. Find the expected value of the payoff of the insurance contract. D. Are the probabilities associated with the ratings of bonds X and Y independent?
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