Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.5%. Long-term risk-free government bonds were yielding 8.7% at that 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%, then at what rate should Rollincoast expect to issue new bonds?
9.2
To determine the rate at which Rollincoast should expect to issue new bonds, we need to consider the changes that have occurred since the issuance of the previous bonds.
First, let's calculate the previous risk premium on BBB bonds. The yield to maturity of the BBB bonds issued two years ago was 11.5%, and the risk-free government bond yield was 8.7%. Hence, the previous risk premium was 11.5% - 8.7% = 2.8%.
Next, we need to calculate the current risk premium on BBB bonds. We are given that the current risk-free government bond yield is 7.8% and that the current risk premium is half of what it was two years ago. Therefore, the current risk premium is 2.8% / 2 = 1.4%.
Finally, to determine the rate at which Rollincoast should expect to issue new bonds, we can add the current risk premium to the current risk-free government bond yield.
Therefore, the rate at which Rollincoast should expect to issue new bonds is 7.8% + 1.4% = 9.2%.