You are considering an investment in 30-year bonds issued by Moore Corporation.

Question

You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 0.30 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

Real risk-free rate = 0.25% Default risk premium = 1.05% Liquidity risk premium = 0.70% Maturity risk premium = 0.65%

a. What is the inflation premium?

b. What is the fair interest rate on Moore Corporation 30-year bonds? (For all requirements, round your answers to 2 decimal places. (e.g., 32.16))

Explanation / Answer

a. Inflation Premium = Return Rate on T Bills - Risk free Real rate

= .30% - .25%

= 0.05% (Ans)

b. Fair Interest rate on Moore Corporation = Real Risk free rate + Inflation premium + Default Risk Premium + Liquidity Risk premium + Maturity risk primium

= 0.25% + 0.05% + 1.05% + 0.7% + 0.65%

= 2.70% (Ans)

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