Corporate bonds: real risk-free rate
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The real risk-free rate is expected to remain constant at 3%. Inflation is expected to be 2% a year for the next 3 years, and then 4% a year thereafter. The maturity risk premium is 0.1% (t-1), where t equals the maturity of the bond. (The maturity risk premium on a 5 year bond is 0.4%.) A 5 year corporate bond has a yield of 8.4%.
What is the yield on a 7-year corporate bond that has the same default risk and liquidity premiums as a 5-year corporate bond??
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Solution Summary
This solution provides an explanation on how to determine the yield on a 7-year corporate bond that has the same default risk and liquidity premiums as a 5-year corporate bond.
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Yield on a five year corporate bond = real risk free rate + inflation premium + maturity risk premium + liquidity premium + default ...
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