A particular security's equilibrium rate of return is 8 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 3.5 percent. The security's liquidity risk premium is .25 percent and maturity risk premium is .85 percent. The security has no special covenants. Calculate the security's default risk premium.
In its simplest form, the required rate of return on a security is calculated thusly:
Required rate of return = real (risk-free) rate of return + inflation ...
This solution illustrates how to compute a security's default risk premium.