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Assume that the bonds of highly byHy corporation currently have a yield to maturity of 8% and are due in 1 year. Meanwhile, assume that 1 year treasury securities are yielding 1%.Also assume that investors expect that there is a 4% probability that Byhy Corporation will default within the next year and that if it defaults they will only be able to recover 30% of the maturity value of the corporation`s bonds.

a) Suppose that several prominent highly leveraged corporations( other than ByHy) default on their bonds. What would you expect to happen to the price of ByHy`s bonds and why? Discuss the effects on ByHy`s bonds price of changes in expected and required rates of return.

b) Assume that after news of the defaults by other highly leveraged corporations, investors now expect an 8% probability of default and a recovery rate of 20% in the event of default on ByHy`s bonds. Also assume that increased uncertainty about the future of the high yield market has caused the required rate of return on ByHy`s bonds to change to 10%.What will be the new yield to maturity on the ByHy`s bonds?

Microeconomics, Economics

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