Question

In​ mid-2009, Rite Aid had​ CCC-rated, 12​-year bonds outstanding with a yield to maturity of 17.3 %. At the​ time, similar maturity Treasuries had a yield of 3 %. Suppose the market risk premium is 6 % and you believe Rite​ Aid's bonds have a beta of 0.37. The expected loss rate of these bonds in the event of default is 50 %.

a. What annual probability of default would be consistent with the yield to maturity of these bonds in​ mid-2009?

b. In​ mid-2015, Rite-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?

Answer 1

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Answer:

A)

Rd=3%+0.37(6%) = 5.22%

=y - pL=17.3% -p(0.55)

p=(17.3%-5.22%)/0.50= 24.16%

B)  

= 1.3% + 0.37*6% = 3.52%

p=(7.3% - 3.52/0.50=7.56%