Problem
Consider the case of five possible rating states, A, B, C, D and E (shown in sheet "TransitionMatrix"). A, B and C are initial bond ratings, D symbolizes first-time default, and E indicates default in the previous period. The transition matrix is shown in sheet "TransitionMatrix".
• A 10-year bond issued today at par with an A rating is assumed to bear a coupon rate of 7%. If the bond is issued today at par with a C rating and with a recovery percentage of 50%, what should be its coupon rate so that its expected return will be 7%?