Question

Eleanor Burns is attempting to find the nominal rate of interest for a security. She has...

Eleanor Burns is attempting to find the nominal rate of interest for a security. She has gathered the following​ data:

Characteristic Security
Time to maturity 12 years
Inflation expectation premium 6.0%
Risk premium for:
       Liquidity risk 1.2%
       Default risk 3.4%
       Maturity risk 0.9%
       Other risk 1.5%

.... a.  If the real rate of interest is currently 3​%, find the​ risk-free rate of interest applicable to the security.

b.  Find the total risk premium attributable to the​ security's issuer and issue characteristics.  

c.  Calculate the nominal rate of interest for the security.  

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Answer #1

A)Risk free rate = (1+real rate)*(1+Inflation) - 1

             = (1+.03)*(1+.06)- 1

              = 1.0918- 1

              = .0918 or 9.18%

b)total risk premium attributable to the​ security's issuer and issue characteristics = Liquidity risk+ Default risk+Maturity risk+    Other risk

   =1.2+3.4+.9+1.5

   = 7%

c)nominal rate of interest for the security.= Real rate - Risk premium

               = 9.18 - 7

                = 2.18%

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