You are reviewing a proposed purchase of a 5-year corporate bond position for a fixed income portfolio. The investment committee wants a recommendation on whether the risk-adjusted return is attractive versus a comparable Treasury, and you need to frame the analysis using market risk and credit risk rather than a generic qualitative view. Assume annual periods, USD reporting, and that if default occurs, no further coupons are received after the recovery payment.
| Metric | Value |
|---|---|
| Face value to purchase | $10,000,000 |
| Purchase price | 98.0% of par |
| Annual coupon rate | 6.0% |
| Years to maturity | 5 |
| Comparable Treasury yield | 4.0% |
| Annual default probability | 2.0% |
| Recovery rate on par if default occurs | 40.0% |
| Estimated annual price volatility | 7.0% |
How would you evaluate the risk of this investment and decide whether the expected return compensates for its credit and market risk relative to the Treasury alternative? Walk through the numbers you would compute and what recommendation you would make.