Camilering CAPM ghen te betal\" a 7year bond the eagected \"etamenn b (Ro.nd to

Question

Camilering CAPM ghen te betal" a 7year bond the eagected "etamenn b (Ro.nd to two dech.-places) How do your results compare? (Select trom the drop down men While both estimales are rough approximations tvay both comha th epected ram of KB Home's debt is ll s promised yiekd Data Table TABLE 12.3 Average Debt Betas by Rating and Maturity" A and abowe B88 By Rating Avg Beta By Maturity Avg Beta S S Schuacfer and I.Steebalaey, "Rik in Capital Stracture Arhicrags"Standond GSB woking c 0,05 0.10 0.17 0.26 0.31 (BBB and above) 1-5 Yar 5-10 Yoar 10-15 Yor 15S Yr 0.01 0.07 0.14 paper, 2009

Explanation / Answer

1) Rd = Yield to Maturity Prob(default) × Expected Loss Rate Rd = 8.5% 8% × 60% 3.70% Probability of default for BB-rated bonds in recession– it is 8%. The average loss for the unsecured debt is 60% 2) Rd = Rf + Beta x MRP Rd = 3.2% + .17 x 5.1% 4.07% 3) First Approach cost of debt is less than the second approach due to low rating of debt, as well as the recessionary economic conditions at the time. 4) While both estimates are rough approximations, they both confirm that the expected return of KB Home’s debt is well below its promised yield

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