Question

In mid-2009, Rite Aid had CCC-rated, 10-year bonds outstanding with a yield to maturity of 17.3 % At the time, similar maturity Treasuries had a yield of 4 % Suppose ua the market risk premium is 6 % and you believe Rite Aid's bonds have a beta of 0.31. The expected loss rate of these bonds in the event of default is 54 % a. What annual probability of default would be consistent with the yield to maturity of these bonds in mid-2009? b. In mid-2015, Rte-Aid's bonds had a yield of 7.3 % , while similar maturity Treasuries had a yield of 1.3 % What probability of default would you estimate now? 015 abil a. What annual probability of default would be consistent with the yield to maturity of these bonds in mid-2009? The required return for this investment is% (Round to two decimal places) t A cybai 1152 A) Rd B) pi Com

Answer 1

Solution :-

(a)

Rd = Rf + Beta*(Risk Premium) = 4% + 0.31*(6%) = 5.86%

Rd = Y - pL

Where P is Probability

5.86% = 17.3% - p(54%)

0.54 p = 11.44%

p = 11.44% / 0.54 = 21.19%

(b)

p = (7.3% –1.3% –0.31(6%)) / 0.54 = 7.667 %