Question #1
Given the recent high-yield bond yield-to-maturity spread of about 800bps, and considering that the expected default rate and recovery rates in 2016 will be equal to the history averages (3.7% [slide 11] and 39.0% [slide 105] respectively), what could be the Expected Return Spread for the year 2016 for an investment in an Index of high-yield bonds?
What would be the Expected Return Spread if the expected default rate was 5.2% and the expected recovery rate was equal to 35.0%?
Question 2
What is the expected Return on Equity for the equity tranche in each of the first two years of a five year CLO (Collateralized Loan Obligation)?
Information:
- $2.0 billion dollar pool.
- Fees are paid at the end of the year and are 1% (of face value) in the first year and 1% (of face value) in the second year.
- Assume that the defaults occur at the beginning of the second-half of each year.
- The recovery from the defaults is invested immediately at (5%).
- The annual interest on the pool of loans (i=10%) is paid semiannually and is based on the remaining balance of loans in the pool.
- The default rates and recovery rates are provided below: Losses are not reduced from equity until the end of the CLO.
Year One Year Two
Default Rate 3% 8%
Recovery Rate 40% 40%
