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The real risk-free rate, r*, is 1.4%. Inflation is expected to average 1.1% a year for...

The real risk-free rate, r*, is 1.4%. Inflation is expected to average 1.1% a year for the next 4 years, after which time inflation is expected to average 3.6% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 9.0%, 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.

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Expert Solution

Inflation Premium for 8-year bond(IP8) = [(1.1%*4)+(3.6%*4)] / 8

= [4.4% + 14.4%]/8 = 18.8%/8 = 2.35%

8-year corporate bond yield = r* + IP8 + MRP + LP + DRP

9% = 1.4% + 2.35% + 0% + 0.7% + DRP

9% = 4.45% + DRP

DRP = 9% - 4.45% = 4.55%

jeff jeffy answered 2 years ago
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