A company\'s 5-year bonds are yielding 8.55% per year. Treasury bonds with the s

Question

A company's 5-year bonds are yielding 8.55% per year. Treasury bonds with the same maturity are yielding 5.65% per year, and the real risk-free rate (r*) is 2.85%. The average inflation premium is 2.4%, and the maturity risk premium is estimated to be 0.1(t - 1)%, where t = number of years to maturity. If the liquidity premium is 1.4%, what is the default risk premium on the corporate bonds?

An analyst evaluating securities has obtained the following information. The real rate of interest is 2.7% and is expected to remain constant for the next 5 years. Inflation is expected to be 2.3% next year, 3.3% the following year, 4.3% the third year, and 5.3% every year thereafter. The maturity risk premium is estimated to be 0.1

Explanation / Answer

A company's 5-year bonds are yielding 8.55% per year. Treasury bonds with the same maturity are yielding 5.65% per year, and the real risk-free rate (r*) is 2.85%. The average inflation premium is 2.4%, and the maturity risk premium is estimated to be 0.1(t - 1)%, where t = number of years to maturity. If the liquidity premium is 1.4%, what is the default risk premium on the corporate bonds?

Solution-

All the components are given to determine the yield on the bonds except the default risk premium and market risk premium.

Calculate the Market risk premium as 0.1%(5

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