Question

# A 5-year Treasury bond has a 4.6% yield. A 10-year Treasury bond yields 6.7%, and a...

A 5-year Treasury bond has a 4.6% yield. A 10-year Treasury bond yields 6.7%, and a 10-year corporate bond yields 9.9%. The market expects that inflation will average 2.4% over the next 10 years (IP10 = 2.4%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.

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1. Default risk premium + Liquidity premium = 10 year corporate bond yield - 10 year treasury bond yield

2. 5 year Corporate bond yield = 5 year treasury bond yield + Default risk premium + Liquidity premium

5 year Corporate bond yield = 4.60% + 3.20%

5 year Corporate bond yield = 7.80% (Answer)

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