A 5-year Treasury bond has a 4.05% yield. A 10-year Treasury bond yields 6.15%,

Question

A 5-year Treasury bond has a 4.05% yield. A 10-year Treasury bond yields 6.15%, and a 10-year corporate bond yields 9.35%. The market expects that inflation will average 2.1% over the next 10 years (IP10 = 2.1%). Assume that there is no maturity risk premium (MRP = 0), and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0). A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described above. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.

Explanation / Answer

Default risk premium and liquidity premium for the 10-year corporate bond = Yield on 10-year corporate bond - Yield on 10 year T-bond

So risk premium = 9.35% - 6.15% = 3.20% As the 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond, we will take this risk premium as 3.2%

Yield on our 5-year corporate bond = yield on 5-year Treasury bond (4.05%) + risk premium (3.2%) = 7.25% is our answer.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.