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In: Finance

suppose the nominal risk-free rate of return in the U.S. is 2.8% and the inflation rate...

suppose the nominal risk-free rate of return in the U.S. is 2.8% and the inflation rate is 1.50%. what is the required rate of return ( or interest rate on a BBB-rated corporate bond with a default risk premium (or default spread) of 1.85%? ignore the liquidity and maturity premiums.

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Expert Solution

It seems simple, but I don't know I am right or not. However, I will try to present it in simple and logical way as possible as I could.

.The required rate of return = Risk free rate + Inflation for given period of time + Default risk

= 2.8 + 1.5% + 1.85%

= 6.15%

Explanation:

- Required rate means, total return required by investors

- Risk free rate means, minimum rate that is risk free, which can be earned by investing in gov. securities.

- Inflation is the increased percentage in cost of goods, so it is required by investor over the period of time.

- Default risk is the credit risk to the BBB rated bond over AAA rated bonds.

.

So, here, the investor requires 6.15% return after considering all things.

jeff jeffy answered 2 years ago
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