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A corporation's 10-year bonds are currently yielding a return of 12.25 percent. The expected inflation premium...

A corporation's 10-year bonds are currently yielding a return of 12.25 percent. The expected inflation premium is 2.75 percent annually and the real interest rate is expected to be 3.00 percent annually over the next 10 years. The liquidity risk premium on the corporation's bonds is 0.25 percent. The maturity risk premium is 0.25 percent on two-year securities and increases by 0.25 percent for each additional year to maturity. What is the default risk premium on the corporation's 10-year bonds? (Round your answer to 2 decimal places. Do not include a percentage sign.)

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Answer #1

10-Year Bond Yield = 12.25%
Inflation Premium = 2.75%
Real Risk-free Rate = 3.00%
Liquidity Risk Premium = 0.25%

Maturity Risk Premium = 0.25% + (t - 2) * 0.25%, where t is greater than 2 years
Maturity Risk Premium = 0.25% + (10 - 2) * 0.25%
Maturity Risk Premium = 0.25% + 8 * 0.25%
Maturity Risk Premium = 2.25%

10-Year Bond Yield = Real Risk-free Rate + Inflation Premium + Liquidity Risk Premium + Maturity Risk Premium + Default Risk Premium
12.25% = 3.00% + 2.75% + 0.25% + 2.25% + Default Risk Premium
12.25% = 8.25% + Default Risk Premium
Default Risk Premium = 4.00%

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