Lunar coast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 12.5 percent. Long-term risk-free government bonds were yielding 8.5 percent at that time. The current risk premium on BBB bonds versus government bonds is half of what it was two years ago. If the risk free long-term government bonds are currently yielding 7.8 percent, then at what rate should Lunar coast expect to issue new bonds?

9.8%

Explanation:

Calculation to determine the what rate should Lunar coast expect to issue new bonds

First step is to calculate the previous risk premium, RPBBB

RP BBB= 12.5% - 8.5%

RP BBB= 4%

Second step is to calculate the previous risk premium new RP BBB:

New RP BBB= 4%/2

New RP BBB= 2%.

Now let calculate the new YTM on BBB bonds: YTM BBB= 7.8% + 2%

YTM BBB= 9.8%

Therefore The rate that that Lunar coast should expect to issue new bonds is 9.8%

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