A company\'s 5-year bonds are yielding 8.3% per year. Treasury bonds with the sa
ID: 2674779 • Letter: A
Question
A company's 5-year bonds are yielding 8.3% per year. Treasury bonds with the same maturity are yielding 5.95% per year, and the real risk-free rate (r*) is 2.85%. The average inflation premium is 2.7%, 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 1.45%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places.____________%
An investor in Treasury securities expects inflation to be 2.45% in Year 1, 3.25% in Year 2, and 4.2% each year thereafter. Assume that the real risk-free rate is 2.05%, and that this rate will remain constant. Three-year Treasury securities yield 6.95%, while 5-year Treasury securities yield 7.65%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Round your answer to two decimal places.
_____________%
The real risk-free rate, r*, is 2.3%. Inflation is expected to average 2.4% a year for the next 4 years, after which time inflation is expected to average 3.9% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 11.85%, which includes a liquidity premium of 0.55%. What is its default risk premium? Round your answer to two decimal places.
_____________%
Explanation / Answer
1. Yield = real risk-free rate + average inflation premium + maturity risk premium + liquidity premium + default risk premium 8.3% = 2.85% + 2.7% + 0.1(5 - 1)% + 1.45% + default risk premium default risk premium = 0.9% 2. Inflation for 3 year bond = (2.45% +3.25% + 4.2% )/3 = 3.3% Inflation for 5 year bond = (2.45% +3.25% + 4.2% *3)/5 = 3.66% Y3 = r* + IP3 + MRP3 6.95% = 2.05% + 3.3% + MRP3 MRP3 = 1.60% Y5 = r* + IP5 + MRP5 7.65% =2.05% + 3.66% + MRP5 MRP5 = 1.94% MRP5 - MRP3 = 1.94%-1.60% = 0.34% 3.Inflation for 8 year = (2.4%*4+3.9%*4)/8 = 3.15% Yield = real risk-free rate + average inflation premium + maturity risk premium + liquidity premium + default risk premium 11.85% =2.3% + 3.15%+ 0+ 0.55% + default risk premium default risk premium = 5.85%
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