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The Hovnanian Enterprises believes the bonds will have a BBB rating. Suppose AAA bonds with the same maturity have a 4.5% yield. Assume the market
The Hovnanian Enterprises believes the bonds will have a BBB rating. Suppose AAA bonds with the same maturity have a 4.5% yield. Assume the market risk premium is 6.4% and use the data in tables below: a reputed home building company plans to issue 6-year bonds. It Annual Default Rates by Debt Rating CC-C AAA AA BBB BB B CCC 0.500% 0.001% 0.130% 1.100% 0.230% 3.10% 2.20% 8.01% 5.50% 12.20% 48.00% 14.10% 79.00% Average In Recession 0.002% 3.20% 16.00% Average Debt Betas by Rating and Maturity A and above BBB CCC BB B 15 years 0.01 0.06 0.07 0.14 (a) Estimate the yield Hovnanian 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 Hovnanian would have to pay if it were a recession, assuming the expected loss rate is 80% at that time, but the beta of debt and market risk premium are the same as in average economic times. What is Hovnanian 's spread over AAA now? (c) In fact, one might expect risk premia and betas to increase in recessions. Redo part (b) as- suming that the market risk premium and the beta of debt both increase by 20%; that is, they equal 1.2 times their value in recessions. The Hovnanian Enterprises believes the bonds will have a BBB rating. Suppose AAA bonds with the same maturity have a 4.5% yield. Assume the market risk premium is 6.4% and use the data in tables below: a reputed home building company plans to issue 6-year bonds. It Annual Default Rates by Debt Rating CC-C AAA AA BBB BB B CCC 0.500% 0.001% 0.130% 1.100% 0.230% 3.10% 2.20% 8.01% 5.50% 12.20% 48.00% 14.10% 79.00% Average In Recession 0.002% 3.20% 16.00% Average Debt Betas by Rating and Maturity A and above BBB CCC BB B 15 years 0.01 0.06 0.07 0.14 (a) Estimate the yield Hovnanian 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 Hovnanian would have to pay if it were a recession, assuming the expected loss rate is 80% at that time, but the beta of debt and market risk premium are the same as in average economic times. What is Hovnanian 's spread over AAA now? (c) In fact, one might expect risk premia and betas to increase in recessions. Redo part (b) as- suming that the market risk premium and the beta of debt both increase by 20%; that is, they equal 1.2 times their value in recessions
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