Biology Forums - Study Force

Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating.  The corresponding risk-free rate is 3% and the market risk premium is 6%.  Assuming a normal economy, the expected return on Rearden Metal's debt is closest to:
A) 0.6%   
B) 1.6%
C) 4.6%
D) 6.0%

C
Explanation:  C) rd = rrf + β(rm - rrf) = 3% + 0.26(6%) = 4.56%

Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating.  The bondholders expected loss rate in the event of default is 50%.  Assuming a normal economy the expected return on Rearden Metal's debt is closest to:
A) 0.6%   
B) 1.6%
C) 4.6%
D) 6.0%

D
Explanation:  D) rd = ytm - prob(default) × loss rate = 8.6% - 5.2%(50%) = 6.00%

Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating.  The bondholders expected loss rate in the event of default is 50%.  Assuming the economy is in recession, then the expected return on Rearden Metal's debt is closest to:
A) 0.6%   
B) 1.6%
C) 4.6%
D) 6.0%

A
Explanation:  A) rd = ytm - prob(default) × loss rate = 8.6% - 16.0%(50%) = 0.6%