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Nominal rate of interest on a 25 year BBB bond in several se

Compute the nominal rate of interest on a 25 year BBB bond issue for a company given the following sets of circumstances:

1. The default risk premium is estimated to be the difference between the average yield on BBB rated bonds (12.75%) and 25 year treasury bonds (5.15%).

2. Due to the questionable economic outlook of similar companies, the liquidity risk premium is estimated to be 3.1%

3. The risk free rate of interest is the difference between the calculated average yield on 3 month treasury bills (3.55%) the inflation rate (3.2%)

4. The maturity premium is estimated to be the difference between the average yield on 25 year treasury bonds (5.15%) and 3 month treasury bills (3.55%).

5. The inflation risk premium is the rate of inflation expected to occur over the life of the bonds.

Please show all work

Solution Preview

r = r* + IP + DRP + MRP + LP
r* = real risk-free rate of return
IP = inflation premium. This is the annual average expected inflation over the life of the bond
DRP = default risk premium
MRP = maturity risk premium
LP = liquidity premium
Nominal rate of interest
Compute the nominal rate of interest on a 25 year BBB bond issue for a company given the following set of circumstances:

1. The default risk premium is estimated to be the difference between the ...

Solution Summary

This solution is comprised of a detailed explanation to compute the nominal rate of interest on a 25 year BBB bond issue for a company given the following sets of circumstances.

$2.19