1 answer

14. Problem 6.13 Click here to read the eBook: The Determinants of Market Interest Rates DEFAULT...

Question:


14. Problem 6.13 Click here to read the eBook: The Determinants of Market Interest Rates DEFAULT RISK PREMIUM The real risk-f
14. Problem 6.13 Click here to read the eBook: The Determinants of Market Interest Rates DEFAULT RISK PREMIUM The real risk-free rate, r, is 2.8 %. Inlation is expected to average 2.55 % a year for the next 4 years, after which time Inflation is expected to average 2.65% a year Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 9.5% , which includes a liquidity premium of 0.7%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places.

Answers

For a Corporate bond,

Nominal Yield = Real risk free rate + Inflation premium + maturity risk premium + Default risk premium + Liquidity premium

Inflation premium is average of inflation over life of bond = [(2.55% * 4) + (2.65% * 4)]/8 = 2.60%

Maturity risk premium = 0

9.5% = 2.8% + 2.60% + 0 + 0.7% + Default risk premium

Default risk premium = 3.40%

.

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