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? (Points: 4)
7.8%
8.7%
9.2%
10.2%
12.9%
9.2
Why did the scarecrow win an award? Because he was outstanding in his field! But speaking of outstanding, let's calculate the expected rate for Rollincoast Incorporated to issue new bonds.
We know that two years ago, the yield to maturity on BBB bonds was 11.5%, and the risk-free government bonds were yielding 8.7%. The risk premium was half of what it was two years ago, and considering that the current risk-free government bonds are yielding 7.8%, we can calculate the expected rate.
So, we start by subtracting the risk premium of half from the previous yield to maturity on BBB bonds: 11.5% - (11.5% - 8.7%) / 2 = 9.2%.
Therefore, Rollincoast Incorporated should expect to issue new bonds at a rate of 9.2%.
To determine the rate at which Rollincoast Incorporated should expect to issue new bonds, we need to calculate the current yield to maturity for BBB bonds.
Given information:
- Two years ago, BBB bonds 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.
- Risk-free long-term government bonds are currently yielding 7.8%.
First, we calculate the change in the risk premium:
Previous Risk Premium = Yield on BBB bonds - Yield on risk-free government bonds
Previous Risk Premium = 11.5% - 8.7% = 2.8%
Current Risk Premium = Previous Risk Premium / 2
Current Risk Premium = 2.8% / 2 = 1.4%
Next, we calculate the current yield to maturity for BBB bonds:
Current Yield on BBB bonds = Yield on risk-free government bonds + Current Risk Premium
Current Yield on BBB bonds = 7.8% + 1.4% = 9.2%
Therefore, Rollincoast Incorporated should expect to issue new bonds at a rate of 9.2%.
To find the rate at which Rollincoast should expect to issue new bonds, we need to calculate the current yield to maturity of BBB bonds.
First, we need to find the risk premium on BBB bonds. The risk premium is the difference between the yield on BBB bonds and the risk-free government bonds. Two years ago, the risk premium was 11.5% - 8.7% = 2.8%.
Now, we know that the current risk premium is half of what it was two years ago, so the current risk premium is 2.8% / 2 = 1.4%.
Next, we need to add the current risk premium to the yield on risk-free government bonds to get the yield on BBB bonds. The yield on risk-free government bonds is currently 7.8%. So, the yield on BBB bonds is 7.8% + 1.4% = 9.2%.
Therefore, Rollincoast should expect to issue new bonds at a rate of 9.2%.
Hence, the correct answer is 9.2%.