Question

The
Gran Group's 5-year bonds yield 6.85%, and 5-year T-bonds yield
4.75%. The real risk-free rate is r* = 2.80%, the default risk
premium for Gran's bonds is DRP = 0.85% versus zero for T-bonds,
the liquidity premium on Gran's bonds is LP = 1.25%, and the
maturity risk premium for all bonds is found with the formula MRP =
(t ? 1) × 0.1%, where t = number of years to maturity. What is the
inflation premium (IP) on 5-year bonds?

Answer #1

Solution: | |||

The inflation premium (IP) on 5-year bonds = 1.55% | |||

Working Notes: | |||

Corporate bond yield = r = rf + IP + MRP + DRP + LP | |||

r Gran= r* + IP + MRP + DRP + LP | |||

6.85% = 2.80% + IP + 0.40 % + 0.85% + 1.25% | |||

IP = 6.85% - 5.30% | |||

IP=1.55% | |||

Notes: | MRP = (t-1) x 0.1% | ||

t= 5 years | |||

MRP = (t-1) x 0.1% | |||

=(5-1) x 0.1% | |||

=4 x 0.1% | |||

=0.40 % | |||

Please feel free to ask if anything about above solution in comment section of the question. |

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