Default Risk Premium of a 5 Year Bond
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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?
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Solution Summary
The solution explains how to calculate the default risk premium on corporate bonds
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The maturity risk premium for 5 years is
MRP5= 0.1%(5-1)=0.4%
The total return is given as
Total Return = Risk free rate k* + ...
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