Question: Rather than take a term loan from the bank Collingwood

Rather than take a term loan from the bank, Collingwood Corp. has decided to issue $50 million of 10-year bonds. DBRS has assigned a rating of “BB” to this bond issue.
a. Determine the probability that no default occurs during the life of these bonds, based on historical average default rates provided in Table 18-6.
b. Valuing long-term bonds with default risk is quite difficult. For simplicity, assume that the bonds mature in one year and can be valued in the same manner as commercial paper. Collingwood Corp. will pay coupon interest (the promised yield) of 10 percent, whereas the current yield on treasury bonds is 6 percent. Use the estimated default rate from part (a) to determine the value of the bonds. You may assume that the bonds are worthless in the event of a default.

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  • CreatedFebruary 25, 2015
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