Explore BrainMass

### Explore BrainMass

Not what you're looking for? Search our solutions OR ask your own Custom question.

This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

The real risk-free rate, k*, is 2.5%. Inflation is expected to average 2.8 perecent a year for the next 4 years, after which time inflation is expected to average 3.75% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 8.3%. Assume that the liquidity premium on the corporate bond is 0.75%. What is the default risk premium on the corporate bond?

#### Solution Preview

(* denotes multiplication, ^ denotes power)

k = k* + IP + LP + MRP + DRP

where

k = required return on a debt security

k* = real risk-free rate of interest= 2.5%

IP = inflation premium= 2.80% for years 0-4 & 3.75% for years 4-8 &

LP = liquidity ...

#### Solution Summary

Default risk premium on a corporate bond is calculated given real risk-free rate, Inflation, Liquidity premium, zero Maturity risk premium.

\$2.49