Question

A company's 5-year bonds are yielding 9.95% per year. Treasury bonds with the same maturity are yielding 5.45% per year, and the real risk-free rate (r*) is 3%. The average inflation premium is 2.05%, and the maturity risk premium is estimated to be 0.1 x (t - 1)%, where t = number of years to maturity. If the liquidity premium is 0.5%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places.

Answer #1

For a corporate bond,

Nominal yield on Corporate Bond = Nominal Yield on Treasury Bond + Liquidity Premium + Default Risk Premium

9.95% = 5.45% + 0.5% + Default Risk Premium

Default Risk Premium = **5.00%**

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