Nielson Motors plans to issue 10-year bonds that it believes will have a 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

Quizplus · Accepted Answer

The yield on BBB bonds is typically higher than AAA bonds due to higher risk. Given the market risk premium of 5% and the expected loss rate of 60%, the yield on BBB bonds would be higher than 3.5% but not as high as 5.5%. Therefore, 4.00% is the closest reasonable yield.

Nielson Motors Plans to Issue 10-Year Bonds That It Believes