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The real risk-free rate, r*, is 3.1%. Inflation is expected to average 2.95% a year for...

The real risk-free rate, r*, is 3.1%. Inflation is expected to average 2.95% a year for the next 4 years, after which time inflation is expected to average 3.5% a year. Assume that there is no maturity risk premium. An 11-year corporate bond has a yield of 11.65%, which includes a liquidity premium of 0.9%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places.

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Expert Solution

For a corporate bond,

Inflation premium is average of inflation over life of bond.

Inflation premium = [(2.95% * 4) + (3.5% * 7)]/11 = 3.30%

11.65% = 3.1% + 3.30% + 0% + 0.9% + Default risk premium

Default risk premium = 4.35%

jeff jeffy answered 2 years ago
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