Question

Suppose 10-year T-bonds have a yield of 4.90% and 10-year corporate bonds yield 6.67%. Also, corporate...

Suppose 10-year T-bonds have a yield of 4.90% and 10-year corporate bonds yield 6.67%. Also, corporate bonds have a 0.32% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.05%. Additionally, the real risk free rate is 0.15%. What is the default risk premium on corporate bonds?

1.45%

1.30%

0.40%

0.95%

Given that,

10 year T bond yield = 4.90%

=> real risk free rate + inflation + maturity risk premium = 4.9%

10-year corporate bonds yield = 6.67%

Liquidity premium on corporate bond = 0.32%

So, Default risk premium = Nominal yield - real risk free rate - inflation - maturity risk premium - Liquidity premium

For corporate bond, nominal yield = 6.67%

=> its default risk premium = 6.67 - 4.9 - 0.32 = 1.45%

So, Default risk premium on corporate bonds = 1.45%

Option A ic correct.

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