Saskatchewan Wheat Fields Inc.is planning to issue $100 million of commercial paper with 30 days to maturity.There is a 1% probability that the firm will default on the issue and the investor will receive zero.The investor's required rate of return is 5%.If the firm wishes to issue the commercial paper at par, the promised yield must be:
A)5%
B)8.25%
C)17.17%
D)42.27%

Question

Quizplus · Accepted Answer

The promised yield can be calculated using the expected return formula. Given a 1% chance of default (where the investor receives 0) and a 99% chance of receiving the promised yield (Y), the expected return (ER) must equal the investor's required rate of return (5%). The formula is: ER = (1% * 0) + (99% * Y) = 5%. Solving for Y gives a promised yield of approximately 17.17%.