Suppose the prospects for recovering principal for a defaulted bond issue depend on which of two economic scenarios prevails. Scenario 1 has probability 0.75 and will result in recovery of $0.90 per $1 principal value with probability 0.45, or in recovery of $0.80 per $1 principal value with probability 0.55. Scenario 2 has probability 0.25 and will result in recovery of $0.50 per $1 principal value with probability 0.85, or in recovery of $0.40 per $1 principal value with probability 0.15.
A. Compute the probability of each of the four possible recovery amounts: $0.90, $0.80, $0.50, and $0.40.
B. Compute the expected recovery, given the first scenario.
C. Compute the expected recovery, given the second scenario.
D. Compute the expected recovery.
E. Graph the information in a tree diagram.
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