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Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.75%. Also, corporate...

Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.75%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?

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Answer #1

For a corporate bond,

Nominal yield on Corporate bond = Nominal yield on Treasury bond + Liquidity premium + Default risk premium

6.75% = 5.30% + 0.25% + Default risk premium

Default risk premium = 1.20%

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