Use the following information to answer the question(s)below.Consider the following information regarding corporate bonds:
-Wyatt Oil has a bond issue outstanding with seven years to maturity,a yield to maturity of 7.0%,and a BBB rating.The bondholders' expected loss rate in the event of default is 70%.Assuming the economy is in recession,then the expected return on Wyatt Oil's debt is closest to:
A)3.5%.
B)4.9%.
C)5.5%.
D)7.0%.

Question

Use the following information to answer the question(s)below.Consider the following information regarding corporate bonds: 
-Wyatt Oil has a bond issue outstanding with seven years to maturity,a yield to maturity of 7.0%,and a BBB rating.The bondholders' expected loss rate in the event of default is 70%.Assuming the economy is in recession,then the expected return on Wyatt Oil's debt is closest to:
A)3.5%. 
B)4.9%. 
C)5.5%. 
D)7.0%.

Quizplus · Accepted Answer

The expected return on Wyatt Oil's debt can be calculated using the following formula:

Expected Return = yield to maturity - (expected loss rate x probability of default)

Since the economy is in a recession, the probability of default increases, so we need to adjust for this. Let's assume that the probability of default in a recession is 20%.

Expected Return = 7.0% - (0.70 x 0.20)

Expected Return = 4.9%

Therefore, the closest expected return on Wyatt Oil's debt is 4.9%, which corresponds to choice B.

Use the Following Information to Answer the Question(s)below