Use the following information to answer the question(s)below.
Consider the following information regarding corporate bonds:
-Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating.Suppose AAA bonds with the same maturity have a 3.5% yield.Assume that the market risk premium is 5% and the expected loss rate in the event of default on the bonds is 60%.The yield that these bonds will have to pay during average economic times is closest to:
A)3.50%
B)3.75%
C)4.00%
D)5.50%

Question

Use the following information to answer the question(s)below.
Consider the following information regarding corporate bonds: 
-Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating.Suppose AAA bonds with the same maturity have a 3.5% yield.Assume that the market risk premium is 5% and the expected loss rate in the event of default on the bonds is 60%.The yield that these bonds will have to pay during average economic times is closest to:
A)3.50% 
B)3.75% 
C)4.00% 
D)5.50%

Quizplus · Accepted Answer

C)For AAA r_d = r_rf + β(r_m - r_rf)= r_rf + 0.05(5%)= 3.5% → r_rf = 3.25% For BBB r_d = r_rf + β(r_m - r_rf)= 3.25% + 0.10(5%)= 3.75% r_d = ytm - prob(default)× loss rate → 3.75% = ytm - 0.4%(60%)→ ytm = 3.99%

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