Chartered Financial Analyst Level 2

Explanation

Correct Answer: A

When estimating the cost of debt for a company, the most appropriate method is to use the yield to maturity (YTM) of the company's own outstanding debt, provided it is publicly traded and has similar characteristics to the debt being evaluated.

Why Option A is Correct:

• The company already has publicly-traded straight debt denominated in US dollars with an A credit rating
• This represents the market's current assessment of the company's credit risk in the US dollar market
• Using the company's own YTM directly reflects its specific credit profile and market conditions
• No adjustments or proxies are needed since the debt is already in the target currency (USD)

Why Other Options Are Less Appropriate:

• Option B: While using peer company bonds with same maturity and rating is a common alternative, it's less direct than using the company's own debt when available
• Option C: This approach would introduce unnecessary complexity and potential inaccuracies by converting Euro-denominated yields and adjusting for country risk, when the company already has USD-denominated debt available

Key Concept:

The cost of debt should reflect the company's specific credit risk in the target currency. When the company has publicly-traded debt in that currency, its YTM provides the most direct and accurate estimate.