11. Default risk premium: A company's 5 year bonds are yielding 7.75% per year. Treasury bonds with the same maturity are yielding 5.2% pre year, and the real risk free rate (r*) is 2.3 %. The average inflation premium is 2.5% 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 1%, what is the default risk premium on the corporate bonds?
The maturity risk premium for 5 years is
The total return is given as
Total Return = Risk free rate k* + ...
The solution explains how to calculate the default risk premium on corporate bonds