Pharmaceutical Co. 5-year long-term bonds currently yield 10%. The real risk free rate is 2%. The maturity risk premium is estimated to be 1% (t-1), where t represents the number of years to maturity. The combined default risk and liquidity premiums for the company issued bonds total 2% and are constant for all bonds issued by the company regardless of the number of years until maturity. If the inflation rate is constant for the first five years and expected to be 5% for year 6, and 6% for year 7, what is the yield on a 7-year long-term bond for Pharmaceutical Co.?

Pharmaceutical Co. 5-year long-term bonds currently yield 10%. The real risk free rate is 2%. The maturity risk premium is estimated to be 1% (t-1), where t represents the number of years to maturity. The combined default risk and liquidity premiums for the company issued bonds total 2% and are constant for all bonds issued by the company regardless of the number of years until maturity. If the inflation rate is constant for the first five years and expected to be 5% for year 6, and 6% for year 7, what is the yield on a 7-year long-term bond for Pharmaceutical Co.?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 1P

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