General Accounting: A particular security's default risk premium is 1 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 3 percent. The security's liquidity risk premium is 5 percent and maturity risk premium is 4 percent. The security has no special covenants. What is the security's equilibrium rate of return?

General Accounting: A particular security's default risk premium is 1 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 3 percent. The security's liquidity risk premium is 5 percent and maturity risk premium is 4 percent. The security has no special covenants. What is the security's equilibrium rate of return?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter6: Fixed-income Securities: Characteristics And Valuation

Section: Chapter Questions

Problem 15QTD

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Calculate a security’s default risk premium where the equilibrium rate of return is 8 percent, the inflation risk premium is 1.25 percent, the real risk-free rate is 3.5 percent, the liquidity risk premium is 0.35 percent, and the maturity risk premium is 0.95 percent and there are no special covenants.
Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Symbol Component This is the rate for a short-term riskless security when inflation Maturity risk premium Inflation premium Liquidity risk premium is expected to be zero. It is calculated by adding the inflation premium to r* This is the difference between the interest rate on a U.S. Real risk-free rate Treasury bond and a corporate bond of the same profile-that Nominal risk-free rate is, the same maturity and marketability. Default risk premium This is the premium added to the risk-free rate that reflects the average sustained increase in the general level of prices for goods and services expected over the security's entire life. This is the premium that reflects the risk associated with changes in interest rates for a long-term security. This is the premium added to the equilibrium interest…
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