In this workout, we are looking at a very simple trade. You expect company A to strengthen in terms of credit worthiness. So you expect company A to do well and that the expected risk there to come down. Assuming no change in the treasury yield curve and a $5 million long position, what will be the resulting profit or loss if the below scenario comes true? At the moment, the risk-free rate is 1.75%. We expect that to be the same, and the current spread is 3%. If we are right, we expect the spread to contract to 1.8%. The bond terms are very simple. The remaining time to maturity is five years. It's got an annual coupon of five, and the par value is 100. So first of all, let's figure out what the price of the bond is right now. And we're gonna use the Excel PV formula there. So equals minus PV. And the first thing we're being asked about is the rate. What is the discount rate we're gonna be using? Well, that will be the risk-free rate, of course, the 1.75, plus the current spread over treasuries, which is 3%.

Close the bracket. The number of periods, of course, is five years. The remaining time to maturity. The payment is the annual coupon, which is five. And the face value of the par value is 100. Close the bracket. And we'd expect to pay at the moment $101.10 per bond here. However, if we are right, we expect the spread over treasuries to contract to 1.8. Let's see what happens to the price then. Or we would, of course, expect the price to come up. Let's see if we can make that happen.

So now the spread is no longer 3%, it's 1.8%. So the total yield to maturity, of course, is going to be 1.75 plus the new spread, 1.8.

The rest of the calculation is the same as before. Five years to maturity, annual coupon on five, and the par value at 100. Close the bracket. And we expect this bond to trade up to 106.5. So assume we made an investment there of 5 million originally, and then of course, the value of that investment after the spread has changed would be the new price, divided by the old price, times the original investment. So we'd expect now the investment to be worth significantly more, and more exactly, to have generated a profit of 269,447. In percentage terms, that would be the profit divided by the original investment, 5.39%. So quite a significant return here. That is, of course, driven by a large change in the credit spread as well as the relatively long duration of this bond. So that improvement in credit spread has five years to work its magic.