Chapter 12, Problem 14P

In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 2.05%.

1. a. What is the highest expected return these bonds could have?
2. b. At the time, similar maturity Treasuries have a yield of 1.5%. Could these bonds actually have an expected return equal to your answer in part (a)?
3. c. If you believe Ralston Purina’s bonds have 0.5% chance of default per year, and that expected loss rate in the event of default is 60%, what is your estimate or the expected return for these bonds?