An old lady known to you as "Granny" has been evaluating an investment proposal from her son, Uncle Sal. Sal suggests that the investment is "too good to pass up," but based on past performance, Granny is suspicious. After doing some research, Granny has determined that Sal's investment has a high risk of default, for which she would require and expect a return of 5% above investments with no such risk. Government bonds of the same maturity are selling for a price that yields a current return of 6%.
What interest rate should Granny use to determine if this investment is worthwhile?
What the Granny requires is 5% above the investments which have no risk of default. The default risk is the possibility of not being able to pay the interest or the ...
The solution explains how to calculate the interest rate to compare investments.