1.) The Dunley Corp. plans to issue 5-year bonds. It believes the bonds will have a BBB rating. Suppose AAA bonds with the same maturity have a 4% yield. If the market risk premium is 5% using the data in the tables

a. Estimate the yield Dunley will have to pay, assuming an expected 60% loss rate in the event of default during average economic times. What spread over AAA bonds will it have to pay?

b. Estimate the yield Dunley would have to pay if it were a recession, assuming the expected loss rate is 86% at that time but the beta of debt and market risk premium are the same as in average economic times. What is Dunley's spread over AAA now?

c. In fact, one might expect risk premium and betas to increase in recessions. Redo part (b) assuming that the market risk premium and the beta of debt both increase by 20%, that is they equal 1.20 times their value in recessions.

Rating:	AAA	AA	A	BBB	BB	B	CCC	CC-C
Default Rate Average	0.0%	0.1%	0.2%	0.5%	2.2%	5.5%	12.2%	14.1%
In recessions	0.0%	1.0%	3.0%	3.0%	8.0%	16.0%	48.0%	79.0%

Average Debt Betas by Rating and Maturity
By rating	A and above	BBB	BB	B	CCC
Average beta	< 0.05	.10	0.17	0.26	0.31
By maturity (BBB and above)		1-5 Yr	5-10 Yr	10-15 Yr	> 15 Yr
Average beta		0.01	0.06	0.07	0.14

2.) Consider the following airline industry data from mid-2009:

a.) Use the estimates in table to estimate the debt beta for each firm (use an average if multiple ratings are listed).

b.) Estimate the asset beta for each firm

c.) What is the average asset beta for the industry, based on these firms?

	Market Capitalization	Total Enterprise Value	Equity Beta	Debt Ratings
Delta	4966.6	16936.6	1.986	BB
Southwest	4862.7	6334.6	.983	A/BBB
JetBlue	1264.6	3898.4	1.882	B/CCC
Continental	1118.6	4365.8	1.969	B

Average Debt Betas by Rating and Maturity
By rating	A and above	BBB	BB	B	CCC
Average beta	< 0.05	.10	0.17	0.26	0.31
By maturity (BBB and above)		1-5 Yr	5-10 Yr	10-15 Yr	> 15 Yr
Average beta		0.01	0.06	0.07	0.14