eBook A company's 5-year bonds are yielding 9% per year. Treasury bonds with the same maturity are yielding 4.2% per year, and the real risk-free rate (r*) is 2.35%. The average inflation premium is 1.45%, and the maturity risk premium is estimated to be 0.1 x (t-1) %, where t = number of years to maturity. If the liquidity premium is 0.8%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places. BO %
eBook A company's 5-year bonds are yielding 9% per year. Treasury bonds with the same maturity are yielding 4.2% per year, and the real risk-free rate (r*) is 2.35%. The average inflation premium is 1.45%, and the maturity risk premium is estimated to be 0.1 x (t-1) %, where t = number of years to maturity. If the liquidity premium is 0.8%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places. BO %
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![### Understanding Bond Yield Concepts
A company's 5-year bonds are offering a yield of 9% per annum. Treasury bonds with the same maturity period have a yield of 4.2% annually, while the real risk-free rate \((r^*)\) stands at 2.35%. The average inflation premium is 1.45%. The maturity risk premium is calculated using the formula:
\[ \text{Maturity Risk Premium} = 0.1 \times (t - 1)\% \]
where \( t \) represents the number of years to maturity. The liquidity premium is noted to be 0.8%.
**Objective**: Calculate the default risk premium on the company's corporate bonds. Present your result rounded to two decimal places.
\[
\text{Default Risk Premium} = \text{Company's Bond Yield} - (\text{Treasury Bond Yield} + \text{Inflation Premium} + \text{Maturity Risk Premium} + \text{Liquidity Premium})
\]
\[
\text{Default Risk Premium} = 9\% - (4.2\% + 1.45\% + 0.4\% + 0.8\%)
\]
Fill in the calculated default risk premium in the text box below:
\[
\boxed{\phantom{0.00\%}}
\]
This explanation is meant for educational purposes to help students understand the components impacting bond yields and how to calculate risk premiums.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F37e2f913-30b2-4c8c-98d5-339163057ff1%2Fbf2f9b88-1efb-4456-9e99-001ece3eb354%2Ftdng4fa_processed.jpeg&w=3840&q=75)
Transcribed Image Text:### Understanding Bond Yield Concepts
A company's 5-year bonds are offering a yield of 9% per annum. Treasury bonds with the same maturity period have a yield of 4.2% annually, while the real risk-free rate \((r^*)\) stands at 2.35%. The average inflation premium is 1.45%. The maturity risk premium is calculated using the formula:
\[ \text{Maturity Risk Premium} = 0.1 \times (t - 1)\% \]
where \( t \) represents the number of years to maturity. The liquidity premium is noted to be 0.8%.
**Objective**: Calculate the default risk premium on the company's corporate bonds. Present your result rounded to two decimal places.
\[
\text{Default Risk Premium} = \text{Company's Bond Yield} - (\text{Treasury Bond Yield} + \text{Inflation Premium} + \text{Maturity Risk Premium} + \text{Liquidity Premium})
\]
\[
\text{Default Risk Premium} = 9\% - (4.2\% + 1.45\% + 0.4\% + 0.8\%)
\]
Fill in the calculated default risk premium in the text box below:
\[
\boxed{\phantom{0.00\%}}
\]
This explanation is meant for educational purposes to help students understand the components impacting bond yields and how to calculate risk premiums.
Expert Solution
Step 1
Data given:
Yield of 5 year corporate bond=9%
Yield of 5 year treasury bond=4.2%
Risk free rate=2.35%
Average Inflation premium =1.45%
Maturity risk premium(estimated)=0.1*(t-1)%
No. of years to maturity=5
Liquidity premium=0.8%
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