B12-16 (bookistatic) During ” lo tha e aga lass ata for unsecured da t isabout 6

Question

B12-16 (bookistatic) During ” lo tha e aga lass ata for unsecured da t isabout 60% annual data it atas b debt ra n hare and a-raga debt batas y ran g an matrt hera Cancidering the prabcbiy af default the expectce rctum of the bendis Round to twa decmal pla:cs Data Table TABLE 12.2 Annual Default Rates by Debt Rating (1983-2011) Rating: Detault Rate Average 0.1% li, Roassions 0.096 1.0% Ssnice: "Corporate Defaults a - 0.2% 3.0% 0.5% 3.0% 2.2% 8.0% 5,5% 16.0% 12.2% 48.0% 14.1% 79.0% and Recovery Rates, 1920 2011, JMosats ol Ceo og, Tebruary 2012 Prim Done

Explanation / Answer

first method:
expected return of debt=YTM-(loss rate*annaul default rate)
from table during recession for bb rating the annual default rate os 8% and loss rate is 60%
=8.5%-(60%*8%)=3.7%
secon method capm approach:
expected return=risk free+(beta*market risk premium)
=3%+(0.17*5%)=3.85%

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