In mid-2009, Rite Aid had CCC-rated, 6-year bonds outstanding with a yield to maturity of 17.3%. At the time, similar maturity Treasuries had a yield of 3%. Suppose the market risk premium is 5% and you believe Rite Aid’s bonds have a beta of 0.31. The expected loss rate of these bonds in the event of default is 60%.
a. What annual probability of default would be consistent with the yield to maturity of these bonds in mid-2009?
b. In mid-2012, Rite-Aid’s bonds had a yield of 8.3%, while similar maturity Treasuries had a yield of 1%. What probability of default would you estimate now?
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