Question

1. 5-year Treasury bonds yield 5.5%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.4%. What is the real risk-free rate, r*?

2. If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

Answer 1

1.

Data:	Yield		5.5%
	NPER		5	Years
	Inflation		1.90%
	MRP		0.4%
	Risk-Free rate		?
	Formula Used:		Bond Yield - Inflation Premium- Maturity Risk Premium
		=	5.5% - 1.90% - 0.4%
		=	3.20%

 

 

 

2.

Data:	T-Bond Yield		6.2%
	Corporate Bond Yield		8.5%
	Risk Premium on Bonds		1.3%
	Liquidity Premium		0.4%
	Default Risk Premium		?
	r = r* + IP + MRP + DRP + LP
	r*, IP, and MRP are included in both bonds, hence are not relevant.
	Liquidity risk premium = LP is included in corporate only						0.4%
	Corporate bond yield		8.5%
	T-bond yield		6.2%
	Difference		2.3%
	Difference = DRP + LP
	2.3 % =	DRP +	0.4%
	DRP =	2.3% - 0.4%
	DRP =	1.9%

DRP = 1.9%