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Suppose you have an initial wealth of $10,000 to invest. A broker phones you with some information on certain junk bonds. If the company issuing the bonds posts a profit this year, it will pay you 40 percent interest rate on the bond. If the company files for bankruptcy, you will lose all you invested. If the company breaks even, you will earn 10 percent interest rate. Your broker tells you there is a 50 percent chance that the company will break even and a 20 percent chance that the company will file for bankruptcy. Your other option is to invest in a risk-free government bond that will guarantee 8 percent interest for 1 year.

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Financial Management, Finance

Category:- Financial Management
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