Question

You read in The Wall Street Journal that 30-day T-bills are currently yielding 0.5%. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums on a 1 year bond:

Liquidity premium = 0.5%.

Maturity risk premium = 0.5%.

Default risk premium = 1%.

On the basis of these data, what is the short term corporate bond rate?

Answer 1

For a short term corporate bond, liquidity premium and default risk premium are added to the risk free rate or current yield of 30-day T-bill. And since maturity premium is applicable to long term bonds, it will not be used in the calculation
Thus, considering the following formula
r = r^*+LP+DRP
where r = short term bond rate
r* = current yield of 30 day T-bill
LP = Liquidity premium
DRP = Default risk Premium

Therefore, r = 0.5+0.5+1.0
   = 2%.

Short term bond rate is 2%.

answered by: anonymous