Rolling Coast Inc. issued BBB bonds two years ago. These bonds provided a yield to maturity (YTM) of 11.5 percent. Long-term risk-free government bonds were yielding 8.7 percent at the time. The current risk premium on BBB bonds versus government bonds is half of what it was two years ago. If the risk-free long-term government bonds are currently yielding 7.8 percent, then at what interest rate should Rolling Coast expect to issue new bonds?

Question

Quizplus · Accepted Answer

The current risk premium on BBB bonds versus government bonds is only half of what it was two years ago. This means that the yield on BBB bonds has decreased relative to risk-free government bonds.

To find the new YTM for Rolling Coast's new bonds, we need to add the current risk premium to the current risk-free rate:

New YTM = Risk-free rate + Risk premium
New YTM = 7.8% + (0.5 * (11.5% - 8.7%))
New YTM = 9.2%

Therefore, Rolling Coast should expect to issue new bonds with a YTM of 9.2%. The answer is choice (C).