You are a large investment bank credit trader considering trading on a new bond for Car Company A. This bond, which is about to be issued is a zero-coupon bond with one year maturity and face value of $1,000,000. Your balance-sheet information about Car Company A is a market capitalization of $44 billion, total debt of $178 billlion, and asset volatility of 22% per annum.
You have also just collected some information on Car Company B which is also a big player in the automobile industry: market capitalization of $30 billion, total debt: $209 billion, and asset volatility of 14% per annum. Company B has also just issued a corporate bond with one year maturity, zero-coupon, face value $1,000,000. This particular bond is priced at $902,737.60, which implies a semi-annual compounding yield of 10.50% p.a.
Determine the price of the Car Company A bond and articulate a trading recommendation. Assume the current 1-year continuously compounding risk-free rate is 2% p.a. You might be concerned you do not have enough information to determine Company A’s recovery rate - first, help determine a reasonable proxy for the recovery rate of the US automobile industry based on the information above or some other outside source.